ST.

MARY UNIVERSITY
SCHOOL OF GRADUATE STUDIES
DEPARTMENT OF ACCOUNTING AND FINANCE

ASSESSMENT OF CREDIT RISK MANAGEMENT PRACTICE OF

COMMERCIAL BANK OF ETHIOPIA

BY
BIRUK DEJENE

A THESIS SUBMITTED TO SCHOOL OF GRADUATE STUDIES OF

ST.MARY’S UNIVERSITY IN PARTIAL FULFULIMENT OF THE
REQUIRMENTS FOR THE DEGREE OF MASTER OF ACCOUNTING AND
FINANCE

ADVISOR: ZENEGNAW A. (PhD)

December 2015
Addis Ababa, Ethiopia
 ST.MARY UNIVERSITY
SCHOOL OF GRADUATE STUDIES
DEPARTMENT OF ACCOUNTING AND FINANCE

ASSESSMENT ON CREDIT RISK MANAGEMENT PRACTICE OF

COMMERCIAL BANK OF ETHIOPIA

BY
BIRUK DEJENE

Approved by the Board of Examiners:

_________________________ ______________________
Dean, Graduate Studies Signature & Date

_________________________ ______________________
Advisor Signature & Date

_________________________ ______________________
External Examiner Signature & Date

_________________________ ______________________
Internal Examiner Signature& Date

I
 Statement of Declaration
I Biruk Dejene declare that this research, titled “Assessment on credit risk management
practice of commercial bank of Ethiopia” is done with my own effort. I have produced it
independently except for the guidance and suggestions of my research advisor. I assure
that this study has not been submitted for any scholarly award in this or any other
university.

Biruk Dejene Signature ––––––––––––––––––––– Date –––––––––––

II
 Certification
Here with I state that Biruk Dejene has carried out this research work on the topic entitled
“Assessment on credit risk management practice of commercial bank of Ethiopia” under
my supervision. This work is original in nature and has not presented for a degree in any
university and it is sufficient for submission for the partial fulfillment for the award of
MSc degree in Accounting and Finance.

Zenegnaw A. (PhD) Signature ––––––––––––––––––––– Date –––––––––––

III
 Abstract
Credit Risk management becomes major discussion issues in the financial institutions
because of uncertainty related to borrower’s business. The aim of this study is to assess
credit risk management tools and technique that are being used in the bank and to what
extent the current performance of the bank is supported by proper credit risk
management policy, procedure and strategy. The study design is descriptive. The
research applies quantitative research method and both primary data (questionnaire)
and secondary data were collected to meet the objective of the study. 106 samples were
involved at head office and district office who works on credit to get reliable and valid
information about the study subject. The data was analyzed using descriptive statistics
technique and frequency table by using SPSS software. From the findings the study
concludes that the bank has well organized credit policy that counter to credit risk they
are exposed to and it also conclude that the bank has good credit granting practice and
uses suitable credit risk assessment tools and techniques including loan follow-up, risk
identification, measuring, evaluating, monitoring and controlling mechanism. However,
the study also concluded that the bank has pitfalls such as absence of training for
customers which results to loan diversion, absence of credit risk model that predict the
risk level of the business and the priority sectors of the bank in terms of credit facility are
highly exposed to credit risk which directly contribute to the increment of NPL. Thus, it is
recommended that Commercial Bank of Ethiopia should develop independent risk
management policy and procedure from credit policy and procedure to overcome those
problems and to take measure on the spot.

Key words: Credit Risk Management, Bank.

IV
 Acknowledgement
First and for most I would like to thank the Almighty God for His help. The completion
of this thesis involved kindly contribution, support and encouragement of many people. I
wish to express my sincere gratitude to my advisor Dr: Zenegnaw Abey for his
encouragement, and support. Without his understanding, patience and useful supervision,
it could be more challenging for me to complete this thesis. I am also very thankful to my
beloved friend Sara Meressa and my brother Endashaw Dejene, my sister Kidest Dejene
and my mother Maregnesh Dema for their support and encouragement. Finally I also
show appreciation to Commercial Bank of Ethiopia staff for their patience and
cooperation in filling questioners.

V
Acronyms and Abbreviations

CBE= Commercial Bank of Ethiopia

NBE= National Bank of Ethiopia
CRM= Credit Risk Management
SPSS= Statistical Package for Social Sciences
KYC= know Your Customer
NPL= Non Performing Loan
MIS= Management Information System
LRM= Loan Review Mechanism
BOD= Board of Director
EL= Expected Loss
EAD= Exposure at Default
LGD= Loss Given Default
SET= Security Financing Transaction
OBS= Off Balance Sheet
GAAP= Generally Accepted Accounting Principle
VAR= Value at Risk
MTM=Mark to Market
DM= Default Mode
RCR=Rural Commercial Banks
SME=Small and Medium Enterprises
CSMI=Credit Scoring Methods for Individual

VI
Contents
Title page…………………………………………………………………………………..I
Statement of Declaration………………………………………………………………….II
Certification….. …………………………………………………………………………III
Abstract…………………………………………………………………………………..IV
Acknowledgement…...…………………………………………………………………...V
Acronyms and abbreviations …………..…………………..……………………………VI
Table of content…………………………………………………………………………VII
List of tables………………………………………………………………………………X
Chapter one ……………………………………………………………………………….1
1. Introduction ............................................................................................................... 12
1.1. Background of the study ........................................................................................ 12
1.2. Statement of the problem ....................................................................................... 14
1.3. Research questions ................................................................................................. 16
1.4. Objectives of the study........................................................................................... 16
1.4.1. General objective. ........................................................................................... 16
1.4.2. Specific objectives .......................................................................................... 16
1.5. Significance of the study........................................................................................ 17
1.6. Scope of the study .................................................................................................. 17
1.7. Organization of the Research Report ..................................................................... 17
Chapter two….. …………………………………………………………………………...8
2. Literature review ........................................................................................................... 19
2.1. Credit risk................................................................................................................... 19
2.1.1. Types of credit risk ............................................................................................. 20
i. Country risk ........................................................................................................ 20
ii. Industry risk .................................................................................................... 21
iii. Pre-settlement risk .......................................................................................... 21
iv. Settlement risk ................................................................................................ 21
2.2. Credit Risk Management ........................................................................................... 21
2.3. Overall life cycle of credit risk management ............................................................. 23
VII
2.4. General measurement principle of credit risk exposure ............................................ 24
a. On-balance sheet exposures ................................................................................... 24
b. Derivative exposures .............................................................................................. 25
c. Securities financing transaction (SFT) exposure ................................................... 25
d. Off balance sheet exposure .................................................................................... 25
2.5. Operating under a sound credit granting process ....................................................... 26
2.6. Principles for the Assessment of Banks’ Management of Credit Risk .................. 26
2.7. Credit risk measurement ............................................................................................ 27
2.8. Credit risk Models...................................................................................................... 28
i. Value at Risk Model (VAR) .................................................................................. 28
ii. The Merton model.................................................................................................. 29
iii. Credit Metrics model .......................................................................................... 29
iv. Internal Rating System .............................................................................................. 29
2.9. Credit scoring System ................................................................................................ 30
2.10. Credit Risk Mitigation ............................................................................................. 32
2.11. Credit Risk Mitigation technique ............................................................................. 32
i. Funded credit protection ........................................................................................ 33
a. Collateral ............................................................................................................ 33
b. On-balance sheet netting ................................................................................ 33
ii. Unfunded credit protection .................................................................................... 33
a. Guarantees .......................................................................................................... 33
b. Loan Commitments ........................................................................................ 34
2.12. Tools of Credit Risk Management ........................................................................... 34
2.13. Empirical studies ...................................................................................................... 36
Chapter three ……………………………………………………………………..……...28
3. Research methodology .............................................................................................. 39
3.1. Research design ......................................................................................................... 39
3.2. Types of data collected and used ............................................................................... 39
3.3. Method of data collection and sampling technique ................................................... 40
3.4. Sampling size ............................................................................................................. 40
VIII
3.5. Target group ............................................................................................................... 41
3.6. Data analysis .............................................................................................................. 41
Chapter four ……………………………………………………….…………………….31
4. Data Analysis, Finding and Discussion ........................................................................ 42
4.1. Data Analysis ............................................................................................................. 42
4.2. Results of data gathered from questionnaire .............................................................. 42
4.3. Background information of respondent and validity, reliability and ethical issues ... 43
4.4. Credit risk assessment ................................................................................................ 45
4.4.1. Level of Credit Risk ............................................................................................ 46
4.5. Credit risk management practice ............................................................................... 47
4.6. Challenges in effective implementation of credit risk management policy ............... 49
4.7. External factor and the effectiveness of CRM ........................................................... 50
4.7. Factors Contributing for Occurrence of NPL ............................................................ 52
4.8. Factor of credit granting process................................................................................ 53
4.9. Advisory service to credit customer .......................................................................... 54
4.10. Credit risk measurement techniques ........................................................................ 55
4.11. Credit risk model...................................................................................................... 56
4.12. Activity performed to reduce credit risk .................................................................. 57
4.13. Credit risk management process .............................................................................. 58
4.14. Credit risk management tools and techniques ..................................................... 64
4.15. Risk reporting........................................................................................................... 65
4.15. Risk mitigation mechanism.................................................................................. 66
4.16. Secondary data analysis ........................................................................................... 67
Chapter five….. ………………………………………………………………………….59
5. Summary of findings and Recommendations ............................................................... 70
5.1.1. Summary of findings............................................................................................... 70
5.1.2. Recommendations ................................................................................................... 72
Reference .......................................................................................................................... 74
Appendix 1: Research Questionnaire

IX
 List of Tables

No. Description Page

Table 1: frequency distribution of respondent by level of education…………………. 31

Table 2: frequency distribution respondent by field of specialization………………… 32
Table 3: frequency distribution Respondent by current position……………………….32
Table 4: frequency distribution respondent by Work experience………………………33
Table 5: Levels of credit risk on loan category by economic sector…………………….34
Table 6: principles of credit risk management used. ………………………………...….35
Table 7:Internal factors and CRM policies of the bank. …………………………….…..37
Table 8:External factors and effectiveness of CRM. ………………………….……….38
Table 9:The extent of facilitating Factors for the occurrence of NPL in the bank……....40
Table 10:The importance of factors considered in credit granting process in the bank....41
Table 11: Response to advisory service to credit customer…………………………….42
Table 12: Extent Credit scoring technique used by the bank……………………….…..43
Table 13: types of credit risk models used in the bank…………………………….…….44
Table 14: level of listed Activities used in order to reduce credit risk by the bank……45
Table 15: credit appraisal………………………………………………………………...46
Table 16: credit administration ………………………………………………………….48
Table 17: monitoring control of credit …………………………………………………. 49
Table 18: Managing the loan recovery process..........................................................…...50
Table 19: tools and techniques of credit risk management …………………………… 52
Table 20: risk reporting Schedules …………………………………………………..….53
Table 21: Credit risk mitigation techniques …………………………………………..…54
Table 22: Total loan and NPL level of different economic sector and beneficiary……...55

X
 Chapter One
1. Introduction

1.1. Background of the study

Banking industry is the largest and most dominant financial sectors which help the
development and growth of countries economic transformation. Bank is a financial
institution which collects deposit from depositors and lend to other business sectors as its
main function.

For most banks, loans are the largest and most obvious source of credit risk Basel (1999).
Kargi (2011) study and find out that there is a significant relationship between bank
performance and credit risk management. Loans and advances and non performing loans
are major variables in determining asset quality of a bank. These risk items are important
in determining the profitability of banks in Nigeria. Where a bank does not effectively
manage its risk, its profit will be unstable.

Credit risk is defined as the potential that a bank borrower or counterparty will fail to
meet its obligations in accordance with agreed terms. The goal of credit risk management
is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure
within acceptable parameters. Banks need to manage the credit risk inherent in the entire
portfolio as well as the risk in individual credits or transactions. Banks should also
consider the relationships between credit risk and other risks. The effective management
of credit risk is a critical component of a comprehensive approach to risk management
and essential to the long-term success of any banking organization. (Greuning &
Bratanovic 2009)

Hinnies (2003) states that despite innovation in the financial service sector over the years,
credit risk is still the major single cause of bank failures, for the reason that more than
80% of a bank’s balance sheet generally related to this aspect of risk management. The
consultative paper issued by Basel (1999) also pointed out that the major cause of serious
banking problem continuous to be directly due to the loose of credit standards for
borrowers and counter parties, poor portfolio risk management and so on.

Loan is typically the largest asset and the predominant source of revenue. As such it is
one of the greatest sources of risk to a bank safety and soundness. The very nature of the
banking business is so sensitive because more than 85% of their liability is deposits from
depositors (Saunders and Cornett, 2005). Banks use these deposits to generate credit for
their borrowers, which in fact is a revenue generating activity for most banks. This credit
creation process exposes the banks to high default risk which might lead to financial
distress including bankruptcy.

The key principles in credit risk management are establishment of a clear structure,
allocation of responsibility and accountability, processes have to be prioritized and
disciplined, responsibilities should be clearly communicated and accountability assigned
thereto. Organizing and managing the lending function in a highly professional manner
and doing so pro-actively can minimize whatever the degree of risk assumed losses.
Banks can tap increasingly sophisticated measuring techniques in approaching risk
management issues with the advancements of technology (Yang, 2013).

The beginning of banking in Ethiopia, as in most other country of the world were non
institutional banking operation were based on the private initiative of merchant or others
possessing or in urgent need of money. Since 1963, Commercial Banks of Ethiopia have
been performing commercial banking activities in Ethiopia. At present the bank has more
than 970 branches and more than 22,000 employees with capital of 303.6 billion assets.
In general CBE is the leading bank in Ethiopia and serve as the major source of finance
to the national development effect. The bank provides different types of credit facilities
such as Overdraft, merchandise loan facility, Pre-shipment Export Credit facility,
Revolving Export Credit Facility, Special Truck Loan Financing, Short term loan,
Medium and long term loans, Agricultural Input Loan, Agricultural Investment Loan,
Coffee farming Term Loan Financing and Microfinance Institution’s Loan. From these
types of loans provided by the bank priorities are given to manufacturing sector,
agricultural sector and export. As indicated in the 2014/15 annual performance the report,
it has been possible to mobilize a total deposit of 48.8 billion birr that makes the Bank’s
deposit position 241.7 billion birr. During the 2014/15 budget year, the Bank disbursed a
total loan of 89.6 billion birr. Therefore, this research assesses credit risk management
practice of the bank and the policy environment and ways of alleviating credit risk also
assessed in the research.

1.2. Statement of the problem

Banking industry is a major source of finance for any type of business it may be in the
form of loan. Loan is one of the mechanisms used by financial institutions as a major
source of income. Also the process of repayment default is also fraud for the institutions.

Non-performing loans or uncollectable loans or bad loans are reducing the profitability of
the bank. This NPL are highly ties huge amount of capital that can be used for productive
purpose by giving loans and advance to various economic sectors and profitable business
and investments in different sectors. At present from the total loans and advance
disbursed amount 111,435,273,000.00 birr which is Birr 1,987,873,000.00 or 1.78% is
under the category of NPL in Commercial Bank of Ethiopia (CBE) as at June 2015.
Even-if the NPL ratio is below the required level of NBE it is increasing in the past five
consecutive years from 293,370,000.00 birr in year 2011 to 1,987,873,000.00 birr in year
2015 (Commercial Bank of Ethiopia, 2015). There are a number of studies on credit risk
management in Ethiopia:

Tibebu (2011) in his paper examine the impact level of credit risk management towards
the profitability of selected commercial banks in Ethiopia in general. He argues that
credit risk management has significant impact on profitability of banks of our country. He
took seven selected banks such as Commercial bank of Ethiopia, Nib International bank,
Dashen bank, Awash International Bank, Bank of Abyssinia, Wegagen Bank and United
Bank.
Hagos (2010) in his study of credit management– A Case Study of Wegagen Bank Share
Company in Tigray Region attempt to indicate the importance of credit management in
financial institutions such as commercial banks, micro finances and others. Thus, the
rationale behind undertaking the study is to deeply investigate the causes of credit
management problems and to suggest the possible solutions that enable the bank to run its
operation in a safest way as credit is known to be the main focus of all banks.

Solomon (2013) assesses credit risk management practice of Nib International Bank S.C
and find out that risk which emanates from credit is due to high degree of credit
concentration in few sector and borrowers, the use of collateral as number one technique
to alleviate credit risk and absence of proper evaluation model. He goes on to state lesser
value for MIS, absence of advisory service, dependency of administration mechanism,
override in appraisal process, absence of proper follow up and no formal way of
penalizing loan officers is the major cause of credit risk in NIB international bank.

Tesfaye (2014) investigates factors influencing credit risk in the Ethiopian commercial
banks. The main purpose of the study is to follow a comprehensive approach towards
identifying credit risk influence factors.

Yalemzewd (2013) assess credit management practice of Bunna International Bank S.C
and analyzed the process of accessing credit, credit control process and credit collection
strategy against non performing loan of the bank.

As mentioned above most of the researches are conducted on different private banks in
which large amount of their loans are dispersed to private business but this paper is
conducted on CBE a government owned bank in which large amount of its loans are
dispersed to government project and on three priority sectors(i.e. manufacturing, export
and agriculture). This gap and the above mentioned problem of NPL call research to
assess the credit risk management practice of Commercial Bank of Ethiopia.

The major issue of this paper is to assess and find out what tools and techniques are used
in the bank and to what extent their current performance are supported by proper credit
risk management policy, procedure and strategy and to what extent Commercial Bank of
Ethiopia can manage its credit risk.

1.3. Research questions

The researcher tries to answer the following question:

 What are the gap between credit risk management practice of the bank and the
theory of credit risk management?
 What are credit risk management techniques and tools used by the bank?
 How does the bank identify, measure, monitor, evaluate and control credit risk?
 Which of the three priority sectors of credit facility is highly exposed to NPL?

1.4. Objectives of the study

1.4.1. General objectives
The general objective of the study is to assess the credit risk management practice
of commercial bank of Ethiopia.

1.4.2. Specific objectives

 To assess credit risk management practice of CBE with theoretical framework.

 To identify which of the three priority sectors of credit facility is highly exposed
to NPL?
 To evaluate the implemented credit risk management technique.
 To review the credit risk management process of CBE.
1.5. Significance of the study

Since credit is the back bone of bank industry in generating income, the outcome of the
study will help policy maker, loan processing and credit appraisal department, credit
administration department and credit risk management department by forwarding
relevant information from outcome of the study in order to improve their credit risk
management practice.

Moreover, the study also have importance for other Ethiopian banks policy makers by
providing empirical data that help in improving or formulating the policy environment for
credit risk management practice of the banks. Also the research will be input for further
study in the area of credit risk management practice.

1.6. Scope of the study

The focus of the research is assessment of credit risk management practice of

Commercial Bank of Ethiopia and the researcher mainly focuses on credit administration,
credit appraisal, customer relationship managers department and related area at head
office level, risk management department and consumer loan at district level in order to
gather relevant information about the area of study.

Therefore, the study is limited to the credit activity and risk management area of
Commercial Bank of Ethiopia on the four districts found in Addis Ababa. Other operation
of the CBE is not the subject matter of this research.

1.7. Organization of the Research Report

This study comprises five chapters. Chapter one provides information on background of
the study, general and specific objective, research question, significance, and definition
of terms, scope of study and statement of the problem. Chapter two reviews literatures by
different authors and theoretical framework and empirical studies on issues related to the
study. Chapter three deals with method of the research, research design, target
population, sampling and data collection method. In chapter four findings, analysis and
discussion will be present, chapter five the last chapter is discussion of the findings puts
conclusion and recommendation of the study.
 Chapter Two
2. Literature review

2.1. Credit risk

Beasens and Gestel(2009) defines credit risk as the risk that a borrower fails to pay and
does not act according to their obligation to service debt. They state that the causes for
the failure to pay could be incapability of the other party to pay or failure to pay on the
due date. Besides they mentioned that by its character credit risk is the most apparent risk
of a bank. In addition to this the writer characterize credit risk by ways of three aspect the
first one is default risk is the possibility that payment is not issued at least within three
month this delay will happen due to Counterparts with a weak financial situation, high
debt burden, low and unstable income have a higher default probability, sector
information and management quality. The second aspect is loss risk or loss given default
(LGD) which is a fraction of exposure in the case of failure to pay and exposure risk is
ambiguity on the accurate amount at risk at the very instant of a future default.

In the same way Singh (2013) states that another term for credit risk is default risk and
defines it as the bank’s risk of loss arising from a counterparty that does not make
payments in accordance with his/her promise. He also points out credit risk is the earliest
and the main source of risk in the banking sector.

Credit risk encompasses both the possibility that a borrower will default by failing to
repay principle and interest in timely manner, and the possibility that the credit quality of
the obligor will deteriorate, leading to an economic loss (Ong, 2006).

Credit risk occur when one of the counter parties to a transaction does not clear up in full
either when the fund are outstanding or on some later date and it may result in bankruptcy
of counterparty (C.Baker, 1998).
According Anuj A. (2011), credit risk is delay of one’s own obligation in accordance with
stetted contractual financial obligation within the deadline of payment by counter party.
Credit risk is the possibility that debtors or borrowers incapability of paying its obligation
in a way that predetermined contractual agreement made during credit approval process
which adversely affect the working environment of the lender.

Credit risk is defined as the probability that a bank borrower or counterparty will fail to
meet its obligations in accordance with contracted terms Basel (2000).

Credit risk arises whenever a lender is exposed to loss from borrower, counterparty, or an
obligor who fail to honor their debt obligation as they have agreed and contracted
Colquitt (2007)

The Basel (2001), defines credit risk as a chance when borrowers fail to repay their loan
partially or fully due to different circumstances. It also state that the extent to which the
bank exposed to higher credit risk will lead to unexpected financial crises and lower
credit risk will minimize the probability of the crises because large amount of profit will
be generated from this department of the bank

2.1.1. Types of credit risk

According to Brown and Moles (2014) there are two sub-types of credit risk country risk
and industry risk which affect multinational enterprises.

i. Country risk
Arise from having contact to individuals and institutions in countries that have legal
systems, business codes and standards that differ from those of the lender. There are four
factors relevant to this. The first is political risk, which arises when a country’s
government is challenged externally or from within national borders. Political risk is
more problematic in long-term lending agreements than for short-term transactions. The
second is Economic risk, which arises from depressed or declining economic stability in a
country. The third factor is currency risk, which always arises with cross-border lending.
Finally, the fourth factor is the enforcement risk from the legal system in the debtor
country. Because a creditor has to go through a foreign legal system, it has been known
for debtors to use their domestic legal process to stand or attempt to avoid paying,
claiming that rules from their home country apply.

ii. Industry risk

This applies particularly when the domestic or international economy is in recession and
the poor economic conditions particularly affect certain industries. Industry structure may
have credit consequences because of the supply chain within which most firms operate. It
is a form of concentration risk.
According to Baesens & Gestel (2009) Credit risk consists of pre-settlement and settlement risk:

iii. Pre-settlement risk

Pre-settlement risk is incapability of borrower to perform their obligation through the life
of loan repayment period. It can occur over long period of time from contractual period
up to settlement. And when the borrower residence countries forbid and block all foreign
payment.

iv. Settlement risk

Settlement risk is the exchange of transaction through the involvement of third party this
may create suitable environment for settlement risk because the default of the third party
during the transaction will directly affect the other party (lender of bank). Longer time
duration, payment in different time zone and different currency is the most important
factor to increase settlement risk.

2.2. Credit Risk Management

According to Singh (2013) credit risk management includes all management function
such as identification, measurement, monitoring and control of the credit risk exposure.
The writer further indicated that for long term achievement of banking sector effective
credit risk management practice is a vital issue in the current business environment and
poor credit risk management policy will create serious source of crisis in the banking
industry.
According to Atakelt (2015) Credit risk management practice define as the process of
analyzing and renewing Credit risk management documents and apply constantly in
actual Credit granting process, Credit administration and monitoring and risk controlling
process with suitable Credit risk environment, understanding and identification of risk so
as to minimize the unfavorable effect of risk taking activities and the effectiveness of
credit risk management process is dependent on different variables such as proper
application of best Risk management documents, Staff quality, Credit culture, devoted
top management bodies, sufficient training program, proper organizational structure,
ample level of internal Control and Performance of intermediation function. This
indicates that credit risk management includes different issues such as developing and
implementing suitable credit risk strategy, policy and procedure, accurate identifications
of risk, best credit granting process, credit administration, monitoring and reporting
process determining and controlling the frequency and methods of reviewing credit
policy and procedure and setting authority and responsibility clearly. Besides he
mentioned that by establishing suitable credit risk environment, acceptable level of credit
limit, best credit granting process, proper monitoring and controlling credit risk and
optimizing risk return of a bank credit risk management develop credit performance.

Cebenoyan & Strahan (2004) examine empirically how active management of credit risk
using loan deal affects capital structure, lending, profits, and risk of banks. They find that
banks which are Active in the loan sales market hold less capital and make more risky
loans than other banks. They conclude that advances in credit risk management improve
credit accessibility rather Than decrease risk in the banking system.

The management of credit risk has become a key objective for all financial institutions across
the world. The goal of credit risk management is to maximize a bank’s risk-adjusted rate of
return by maintaining credit risk exposure within acceptable parameters Basel (1999).

According to Anuj A. (2011) through designing and implementing a Credit Risk

Framework, Performing a Credit Risk Assessment, Building Credit Risk Scoring Models
and Credit Risk Reporting control panel and Forecasting Loan Loss we can construct
effective credit risk management and he also believe that most effective credit risk
management focuses on processes, culture, people and organization because we are
working with them.

“Credit risk management includes both preventive and curative measure. Preventive
measure comprise risk assessment , risk measurement , and risk pricing , early warning
system to pick signal of future default in advance and undertake better credit portfolio
diversification. The curative measure aim at minimizing post sanction loan losses through
steps such as securitization, derivative trade, risk sharing and legal enforcement” (Jain,
2014, p3).

2.3. Overall life cycle of credit risk management

Whither the institution in to bankrupts or profitability depends on the level of credit risk
management strategy and proper implementation credit process in each credit risk
management life cycle.

According to George, Sinba and Murat (2008) they put four levels of credit risk
management life cycle:
1. Collect obligor (borrower) and loan data: Parties needed her is borrower, loan and
external data. The key task and challenges of this stage is interpretation of financial
information, system integration, getting the borrower and loan data, data quality and
getting external rating data.
2. Compute credit risk: In this stage credit risk will be calculated in the form of risk rating
of meaningful differential risk among different firms and exposure. The main task and
challenges her is developing rating model, calculating the probability of default, rating
approach, comprehensiveness of data, comprehensiveness of model, calculating loss
given default (LGD), exposure at default (EAD) and expected loss (EL) are the major
one. 3. Monitoring and managing risk rating: This stage is a stage of monitoring and
managing the risk rating system. The main activity and challenges her is interface with
internal collection, perform back testing of rating, reduction of manual dependency
feedback and alert, develop workflow to manage approval of rating and ensure
notification on external rating change.
4. Managing portfolio and allocation of capital: This level of credit risk management life
cycle is the most difficult and challenging in the financial world today. The most
important activities and challenges of this stage is compute and monitor portfolio risk,
allow transfer of risk, reporting on risk, stress testing /scenario analysis and stress
testing/back testing challenge are the most important activity expected to be performed at
this level.

2.4. General measurement principle of credit risk exposure

“A bank should disclose balances of credit exposures, including current exposure and,
where applicable, future potential exposure, by major categories.” Basel (2000)

According to Basel (2013 & 2014) a bank’s total Exposure Measure is the sum of the
following exposures: (a) on-balance sheet exposures, (b) derivative exposures, (c)
securities financing transaction exposures, and (d) other off-balance sheet exposures. The
specific treatment for these four main exposure categories is defined below.

a. On-balance sheet exposures

Banks must include all on-balance sheet assets in their Exposure Measure including on-
balance sheet derivative collateral and collateral for securities financing transactions
(SFTs) (but excluding some of on-balance sheet derivative and SFT assets. l GAAP
recognizes on-balance sheet fiduciary assets, these assets can be excluded from the
Exposure Measure. Physical or financial collateral, guarantees or credit risk mitigation
purchased are not allowed to reduce on-balance sheet exposures.

On-balance sheet, non-derivative exposures are included in the Exposure Measure net of
specific provisions and valuation adjustments (e.g. credit valuation adjustments).
 b. Derivative exposures

Treatment of derivatives: derivatives create two types of exposure: (a) an exposure

arising from the underlying of the contract and (b) a counterparty credit risk exposure.
The leverage ratio framework uses the method set out below to capture both of these
exposure types. Banks must calculate their derivatives exposures, including where bank
sells protection using a credit derivative, as the replacement cost for the current
exposure plus an add-on for potential

Total Exposure = replacement cost (RC) + add-on

RC = the replacement cost of the contract (obtained by marking-to-market), where the

contract has a positive value.

Add-on = an amount for potential future credit exposure over the remaining life of the
contract calculated by applying an add-on factor to the notional principal amount of the
derivative.

c. Securities financing transaction (SFT) exposure

Securities financing transactions (SFTs) are included in the Exposure Measure according
to the following treatment. The treatment recognizes that secured lending and borrowing
in the form of SFTs is an important source of leverage and ensures consistent
international implementation by recognizing the main differences across accounting
frameworks

d. Off balance sheet exposure

This section explains the incorporation into the Exposure Measure for off-balance sheet
(OBS) items, as defined under the risk-based framework. For example, the OBS items
include commitments (including liquidity facilities), unconditionally cancellable
commitments, direct credit substitutes, acceptances, standby letters of credit, trade letters
of credit, failed transactions and unsettled securities (Basel, 2014).
2.5. Operating under a sound credit granting process

According to Saunders and Allen (2002) & (Thomas (2002)) the expert analyzes five
key factors, subjectively weights them, and reaches a credit decision:
1. Character: A measure of the reputation of the firm, its willingness to repay, and its
repayment history e.g. age factor.
2. Capital: The equity contribution of owners and its ratio to debt (leverage). These are
viewed as good predictors of bankruptcy probability. High leverage suggests a greater
probability of bankruptcy.
3. Capacity: The ability to repay, which reflects the volatility of the borrower’s earnings.
4. Collateral: In the event of default, a banker has claims on the collateral pledged by the
borrower. The greater the priority of this claim and the greater the market value of the
underlying collateral, the lower the exposure risk of the loan.
5. Cycle (or Economic) Conditions: The state of the business cycle; an important
element in determining credit risk exposure, especially for cycle dependent industries.

2.6. Principles for the Assessment of Banks’ Management of

Credit Risk

Financial institutions are facing several problems due to lack of adequate credit risk
management principles, proper implementation credit standards of borrower and
counterparties and poor portfolio risk management or lack of attention to changes in
economic or other circumstances that can lead to worsening in the credit standing of a
bank’s counterparties. Sound principles of banks credit risk management will be covered
on five areas as follows Basel (2000).

i. Establishing an appropriate credit risk environment: The strategy of the bank

should reflect the bank’s tolerance for risk and the level of profitability the bank expects
to achieve for incurring various credit risks. Such policies and procedures should address
credit risk in all of the bank’s activities and at both the individual credit and portfolio
levels. Banks should identify and manage credit risk inherent in all products and
activities.

ii. Operating under a sound credit granting process: Banks must operate within
sound, well defined credit granting criteria. These criteria should include a clear
indication of the bank’s target market and a thorough understanding of the borrower or
counterparty, as well as the purpose and structure of the credit and its source of
repayment.

Kim (1987) state that Credit granting process involves an exchange between the supposed
default risk of the credit application and possible returns from granting requested credit.
iii. Maintaining an appropriate credit administration, measurement and
monitoring process: Banks must monitor the condition of individual credits, including
determining the adequacy of provisions and reserves with consistent rating system in
nature, size and complexity of a bank’s activities with information systems and analytical
technique.
iv. Ensuring adequate controls over credit risk: Banks must establish a system of
independent, ongoing assessment of the bank’s credit risk management processes and
ensure that the credit-granting function is being properly managed and their credit
exposure level.
V. The role of supervisors: Supervisors should conduct an independent evaluation of a
bank’s strategies, policies, procedures and practices related to the granting of credit and
the ongoing management of the portfolio and couch practical limits to restrict bank
exposures to single borrowers or groups of connected counterparties.

2.7. Credit risk measurement

Credit risk measurement relies on the lenders analytics and risk measurement tools rather
than the borrowers. It also has three goals the first one is to limit the credit risk exposure
that the lender accepts when extending the debt. The second goal is to insure that
adequate compensation is earned for risk undertaking. It is concerned with the revenue
and profit margin earned on the products and services that lenders provide. The third goal
is to mitigate the credit risk exposure by structuring transaction to protect against loss as
well as in to asset classes that can be marketed to third party investor Colquitt (2007).

The risk measurement concerns the actual measurement of the risk in a risk grade or on a
total portfolio. The measurement quantifies the actual default risk (probability of default),
the loss risk (loss given default) and the exposure risk (exposure at default). A simple
way of risk measurement is to learn from past data when available (Beasens and Gestel,
2009)

2.8. Credit risk Models

Risk model deals with the understanding and prediction of risk levels (Beasens and
Gestel, 2009)
Credit risk modeling methodologies allow a tailored and flexible approach to price
measurement and risk management. (Basel, 1999)

i. Value at Risk Model (VAR)

It is one of the newer risk management tools. The Value at Risk (VAR) indicates how
much a firm can lose or make with a certain probability in a given time horizon. VAR
summarizes financial risk inherent in portfolios into a simple number. Though VAR is
used to measure market risk in general, it incorporates many other risks like foreign
currency, commodities, and equities. (Thirupathi K. & M. Manojkumar (2013)

Credit VAR models can be gathered in two main categories: 1) Default Mode models
(DM) and 2) Mark-to-Market (MTM) models. In the former, credit risk is identified with
default risk and a binomial approach is adopted. Therefore, only two possible events are
taken into account: default and survival. The latter includes all possible changes of the
borrower creditworthiness, technically called “credit migrations”. In DM models, credit
losses only arise when a default occurs. On the other hand, MTM models are
multinomial, in that losses arise also when negative credit migrations occur (Altman,
2006).
 ii. The Merton model
The basic intuition behind the Merton model is relatively simple: default occurs when the
value of a firm’s assets (the market value of the firm) is lower than that of its liabilities.
The payment to the debt holders at the maturity of the debt is therefore the smaller of two
quantities: the face value of the debt or the market value of the firm’s assets. Under these
models, all the relevant credit risk elements, including default and recovery at default, are
a function of the structural characteristics of the firm: asset levels, asset volatility
(business risk) and leverage (financial risk). The RR is therefore an endogenous variable,
as the creditors’ payoff is a function of the residual value of the defaulted company’s
assets Altman (2006). The probability of a firm going bankrupt depends crucially on the
beginning period market value of that firm's assets relative to its outside debt and the
volatility of the market value of a firm's assets (Altman & Saunders, 1998).

iii. Credit Metrics model

Credit Metrics is a tool for assessing portfolio risk due to changes in debt value caused by
changes in obligor credit quality. We include changes in value caused not only by
possible default events, but also by upgrades and downgrades in credit quality. Also, we
assess the value-at-risk (VAR) the volatility of value not just the expected losses.
Importantly, we assess risk within the full context of a portfolio. We address the
correlation of credit quality moves across obligors. This allows us to directly calculate the
diversification benefits or potential over-concentrations across the portfolio. In addition,
Credit Metrics allows us to capture certain market risk components in our risk estimates.
These include the market driven volatility of credit exposures like swaps, forwards, and
to a lesser extent, bonds. J.P Morgan (1997)

iv. Internal Rating System

An internal rating system assist financial institutions to manage and control credit risks
they face through lending and other operations by grouping and managing the credit-
worthiness of borrowers and the quality of credit transactions. Thirupathi K. & M.
Manojkumar (2013)
Capital market looks to credit rating as a determinant of an obligor’s financial health.
Rating agencies use different grading system to rank borrower according to their ability
to service their obligations (Ong, 2006).

2.9. Credit scoring System

According to Hussein & John (2011) Credit scoring has been regarded as a core appraisal
tool in which the idea of reducing the probability of a customer defaulting, which predicts
customer risk, is a new role for credit scoring, which can support and help maximize the
expected profit from that customer for financial institutions, especially banks. One of the
most important things, to classify a bank’s customers, as a part of the credit evaluation
process to reduce the current and the expected risk of a customer being bad credit, is
credit scoring. Hand & Jacka, (1998, p. 106)

Credit scoring is purely judgmental approach in which credit analyst decision is based on
five Cs (i.e. character, capacity, capital, collateral and condition). Thomas (2002)

According to Beasens and Gestel (2009) Credit scoring is a credit risk management
technique that analyzes the borrower’s risk. In its early meaning, “credit scores” were
assigned to each customer to indicate its risk level. The more highly discriminative the
scoring system, the better are the customers ranked from high to low risk. Commonly
focuses on the values of the 5 Cs of a customer (i.e., Character, Capital, Collateral,
Capacity and Condition.)

Credit scoring is the set of decision models and their underlying techniques that aid
lenders in the granting of consumer credit. These techniques assess, and therefore help to
decide, who will get credit, how much credit they should get, and what operational
strategies will enhance the profitability of the borrowers to the lenders (Thomas, 2000).

The judgmental techniques rely on the knowledge and both past and present experience
of credit analysts, who evaluate the required requisites, such as the personal reputation of
a client, the ability to repay credit, guarantees and client’s character. (Abdou, El-Masry &
Pointon, 2007).

Credit scoring is mechanical system for analysis of the loan applicant and used to
increase the correctness in the approval of loans to creditworthy customers, which can
result in increased profits or rejection of those customers who are not creditworthy.
The main reasons for the use of credit scoring are to reduce bad debts and to improve
operational efficiency (Janeska, Sotiroski, & Taleska, 2014).

The main aspect generally used in credit scoring models include the borrowers’’ personal
characteristics such as income, age, gender, education, occupation, region, time at present
address, residential status, marital status, and followed by the borrower’’ banking
relationship such as collateral value, loan duration, time with bank, number of loans, and
current account (Marian G. & Fotini G., 2010, p.15).

According to Beasens and Gestel(2009) Different customer scoring stage are listed as
follows: Marketing score: a marketing activity aims to reduce the cost of customer
acquisition and to minimize customer inconvenience and dissatisfaction. Application
score: Application scoring systems summarize all applicant information into one overall
score measuring the creditworthiness of loan applicants in order to predict the probability
of repayment problem. Fraud score: simply by observing and counting the number of
days in payment arrears, to claim as fraudulent or a credit application as containing
fraudulent information. Performance score: The goal of performance scoring is to
monitor the existing portfolio, its future performance and losses. Behavioral score:
Behavioral scoring analyzes the risk of existing customers based on their recently
observed behavior once credit has been granted, banks can subsequently start to monitor
the repayment and financial behavior of their customers. It allows lenders to make better
decisions in managing existing clients by forecasting their future performance Thomas
(2002). The behavior score analysis the customer’s previous payment and purchase
behavior as well as the customer’s social demographic (Charlotte & Camilla, 2010).
Early warning score: Early warning systems aim to early detect potential crises with
counterparts. These counterparts are put on a watch list for closer inspection and follow
up. Collection score: Collection scoring is a decision support tool to manage bad debt.
One rank orders customers already in payment arrears based on the probability of
successfully collecting the outstanding debt. Profit score: Developing customer level
profit scoring models is typically very complex because of several practical
implementation issues. Direct and indirect benefits and costs need to be considered and
also the timing of the cash flows and the corresponding discount factors need to be taken
into account. Credit lenders wish to change from minimizing the risk of a consumer
defaulting to maximizing the profit a consumer brings them Thomas (2002).

2.10. Credit Risk Mitigation

According to Dohnal (2008) Credit Risk Mitigation (CRM) defined as a mechanism used
by different credit institution in order to minimize their credit risk related with exposure
which the institution continuous to hold. He also further point to that credit risk
mitigation techniques can be distinguish in to two parts the first one is funded credit
protection which includes real estate and financial instrument. The reduction of the credit
risk exposure of a credit institution draw from the right of the credit institution in case of
default to liquidate or retain, to obtain transfer or appropriation of certain assets, to retain
certain assets, to reduce the amount of the exposure and to replace the amount of the
exposure. The other one is unfunded credit protection which includes guarantee. The
reduction of the credit risk exposure of a credit institution derives from the responsibility
of a third party to pay an amount in the occasion of borrowers incapability to pay their
loan or on the incidence unexpected events.

2.11. Credit Risk Mitigation technique

“A bank should disclose the effect of credit risk mitigation techniques, including
collateral, guarantees, credit insurance and legally enforceable netting agreements”.
(Basel 2000)
 i. Funded credit protection

a. Collateral
Collateral is an asset that serves as security against counter party risk. Anderson and
Joeveer(2014)
A collateralized transaction is a transaction where the credit exposure or potential credit
exposure of the credit institution to a counterparty is hedged in whole or in part by
collateral posted by the counterparty or by a third party on behalf of the counterparty.
Basel (2004)
Collateralized credit exposures must have a risk biased exposure amount less than the
same credit exposure without credit protection. The collateral can be in the form of real
estate, receivable and other form of physical collateral. Dohnal (2008)

b. On-balance sheet netting

According to Basel (2004) Banks where legally enforceable netting arrangement for
loans and deposits they may calculate capital requirement on the bases of net credit
exposure. The claim between the credit institution and counter party may be recognized.
They also indicated that Master netting agreements covering repurchase transactions
and/or securities or commodities lending or borrowing transactions and/or other capital
market driven transactions.

ii. Unfunded credit protection

The amount that the safety provider has carried out to pay in the event of the default or
non-payment of the borrower or on the event of other specified credit situation is the
value of unfunded credit protection. where the amount that the protection provider has
carry out to pay is not higher than the exposure value, the value of the credit protection
shall be reduced by 40%; where the amount that the protection provider has carry out to
pay is higher than the exposure value, the value of the credit protection shall be no higher
than 60% of the exposure value Basel (2004)

a. Guarantees
A guarantee must represent a direct claim on the guarantor with the extent of the cover
being clearly defined and unquestionable. A guarantee must be irrevocable; there must be
no clause in the guarantee that would allow the guarantor to cancel unilaterally the cover
of the guarantee or that would increase the effective cost of cover as a result of
deteriorating credit quality in the guaranteed exposure. A guarantee must also be
unconditional; there should be no clause in the guarantee outside the direct control that
could prevent the guarantor from being obliged to pay out in a timely manner in the event
that the original counterparty fails to make the due payment. The indirect guarantee
covers all credit risk elements of the claim; both the original guarantee and the indirect
guarantee meet all the operational requirements for guarantees except that the indirect
guarantee need not be direct and explicit to the original claim. Basel (2008)

b. Loan Commitments
A loan commitment is a facility which gives the obligor the option to borrow at his own
discretion. In practice, this essentially means both a loan (equal to the amount currently
drawn on the line) and an option to increase the amount of the loan up to the face amount
of the facility. The counterparty pays interest on the drawn amount, and a fee on the
undrawn amount in return for the option to draw down further. For these exposures three
factors influence the revaluation in future rating states: the amount currently drawn;
expected changes in the amount drawn that are due to credit rating changes; and the
spreads and fees needed to revalue both the drawn and undrawn portions. All of these
factors may be affected by covenants specific to a particular commitment. J.P Morgan
(1997)

2.12. Tools of Credit Risk Management

According to Sunitha and J. K. Raju (2013), Thirupathi & M. Manojkumar (2013) ,

Bhaskar (2014) and Nayan & M.Kumaraswamy (2014) the tools through which credit
risk management is carried out are:

a) Exposure Ceilings: Prudential Limit is linked to Capital Funds - say 15% for
individual borrower entity, 40% for a group with additional 10% for infrastructure
projects undertaken by the group, Threshold limit is fixed at a level lower than Prudential
Exposure; Substantial Exposure, which is the sum total of the exposures beyond
threshold limit should not exceed 600% to 800% of the Capital Funds of the bank (i.e. six
to eight times).

b)Review/Renewal: Multi-tier Credit Approving Authority, constitution wise delegation

of powers, Higher delegated powers for better-rated customers; discriminatory time
schedule for review/renewal, Hurdle rates and Bench marks for fresh exposures and
periodicity for renewal based on risk rating, etc are formulated.

c) Risk Rating Model: Set up comprehensive risk scoring system on a six to nine point
scale. Clearly define rating thresholds and review the ratings periodically preferably at
half yearly intervals. Rating migration is to be mapped to estimate the expected loss
d) Risk based scientific pricing: Link loan pricing to expected loss. High-risk category
borrowers are to be priced high. Build historical data on default losses. Allocate capital to
absorb the unexpected loss.
e) Portfolio Management: The need for credit portfolio management emanates from the
necessity to optimize the benefits associated with diversification and to reduce the
potential adverse impact of concentration of exposures to a particular borrower, sector or
industry. Stipulate quantitative ceiling on aggregate exposure on specific rating
categories, distribution of borrowers in various industry, business group and conduct
rapid portfolio reviews.
f) Loan Review Mechanism: This should be done independent of credit operations. It is
also referred as Credit Audit covering review of sanction process, compliance status, and
review of risk rating, pickup of warning signals and recommendation of corrective action
with the objective of improving credit quality. It should target all loans above certain cut-
off limit ensuring that at least 30% to 40% of the portfolio is subjected to LRM in a year
so as to ensure that all major credit risks embedded in the balance sheet have been
tracked.
2.13. Empirical studies

Different researchers were conducted on this area of studies in different financial

institutions.
Yang Wang, (2013) find out that the key principles in credit risk management are
establishment of a clear structure, allocation of responsibility and accountability,
processes have to be prioritized and disciplined, responsibilities should be clearly
communicated and accountability assigned on his research title Credit Risk Management
in Rural Commercial Banks in China.

Atkilti (2015) in his study find out that Credit risk, liquidity risk and operational risk are
the three important types of risks the banks mostly facing. The three widely used Risk
identification method were identified and ranked as Financial Statement Analysis firstly
and followed by audit and physical inspection and then internal communication. The
study further confirmed that four aspects of Basel’s Credit risk management principles
explain a significant level of variation on Credit risk management practice of Ethiopian
commercial banks. Furthermore, Establishing an appropriate Credit risk environment and
Ensuring adequate Controls over credit risk were found to be the most influential
variables on level of Credit risk management practice. It is finally observed insignificant
difference between public and private commercial banks in all aspect of Credit risk
management principles and practice.

Girma (2011) point out on his study credit risk management and its impact on
performance in Ethiopian commercial banks that the default ratio of any bank in Ethiopia
depends on credit risk management quality of the institution.

Solomon (2013) studied credit risk management practice of Nib International Bank of
Ethiopia and in his assessment the researcher come across that factors lead to wrong
decision making and increase NPL level of the bank are concentration of credit in few
sector and borrower, collateral as number one technique of credit risk management,
absence of credit risk model of credit portfolio, lesser attention for MIS and advisory
service to customers and absence of proper follow up.

Tibebu (2011) examined that credit risk management and profitability of commercial
banks in Ethiopia. Find out that Both nonperforming loan ratio and capital adequacy ratio
has a negative impact on profitability‘s of commercial banks in Ethiopia. He also state
that the impact level of nonperforming loan ratio is negative which means, a single unit
increase in nonperforming loan ratio leads in (.594077) decrease of profitability of
commercial banks of Ethiopia.

Tesfaye (2012) study factors influencing the level of credit risk in the Ethiopian
commercial banks. The study find out that quantity of risk and quality of risk
management related variables has got much influence on the credit risk level of banks.
Nevertheless, risk direction related measures, which are mostly external focus, have
limited influence on credit risk. More specifically the variation in the effect of stock and
flow measures entails banks to further enhance mostly two of Basel principles: operating
under a sound credit granting process and maintaining an appropriate credit,
administration, measurement and monitoring process.

Akotey J.O. (2012) the study has examined the credit risk management of selected rural
banks in Ghana and has discovered that credit risk management plays a significant and
dynamic role in the business of rural banking. The researcher find out sampled ruler
commercial banks have poor credit risk management practices and hence the high levels
of the non-performing loans in their loans portfolios. Despite the high levels of the NPLs,
their profit levels keep rising as an indication of the transfer of the loan losses to other
customers in the form of large interest margins. Therefore the findings indicate a
significant positive relationship between non-performing loans and rural banks’
profitability informative that, there are higher loan losses but banks still earn profit.

Bajpai et.al. (2015) The researcher find out that BPR Ltd has a credit management
system however it needs to be reviewed and adopted more to current Rwandan
environment. The researcher also indicated that there is a direct relationship between
credit risk management and profitability of commercial banks and recommended that
BPR Ltd should review and improve its credit policy and adopt it to Rwandan market and
context and BPR Ltd should provide continuous training and bring up to date its staffs.
 CHAPTER THREE
3. Research methodology

3.1. Research design

In this study the researcher uses descriptive type of research and the researcher tries to
describe the credit risk management practice, and the controlling mechanism and
measurement tools and techniques of the Commercial Bank of Ethiopia.
Besides, the study deeply described these variables by using both primary and secondary
data. The primary data was collected by distributing structured questioner to credit
administration and appraisal department, consumer loan, risk management and loan
recovery department and secondary data from annual reports (in order to know the
progress of NPL), credit policy and procedures, central bank directive and other relevant
document was used to analyze the extent of implementation.
Finally, the collected data from both primary and secondary data was analyzed,
summarized, concluded and recommended accordingly.

3.2. Types of data collected and used

In this study the researcher used both primary and secondary data. The primary data was
collected through questioner and the secondary data, was collected from credit policy and
procedures and central bank directives to analyze the extent of implementation and CBE
annual report used to see the progress of NPL. In addition to this, Secondary data was
used to collect the information which was not addressed by the questioner or to get more
clarification on other issues such as detailed policy, structure of credit risk management
practice of Commercial Bank of Ethiopia.
3.3. Method of data collection and sampling technique

In order to select relevant respondent stratified random sampling was used. The
population of the study was segmented in to different branches and head office.
Respondent was selected from the segment randomly. The researcher used this sampling
technique because it helps to gather relevant information from the concerned department
(i.e. credit and risk management area of the bank both at head office and district level)

3.4. Sampling size

Commercial Bank of Ethiopia has 971 branches of these branches 175 and four district
offices exist in Addis Ababa as of Jun, 2015. For this study only credit appraisal and
management department, loan recovery, credit analyst expert and expertise in risk
management department at head office level and consumer loan ( credit administrator and
manager relationship and consumer loan officer) department at district level which exist
in Addis Ababa was selected as a sample. Because almost all grade one up to four
branches do not involved on credit assessment and approval process of credit because the
process of credit approval from credit appraisal to approval were under authority of head
office level departments for all district under Addis Ababa except consumer loan.
The total sample size selected was from 152 individual 110 employees were selected
from head office from different credit and risk management department. The total sample
size selected and number of participants in the study was 110.
Formula:
1. n= N/1+Ne^2 =152/1+152*0.05^2
= 110
Description:
n= required sample size
t= confidence level at 95% (standard value of 1.96)
p=estimated employees at CBE head office and district level credit professionals.
m= margin of error at 5% (standard value of 0.05)
3.5. Target group

Everyone who works at a bank has different qualification, knowledge and experience
even for those who work at the same department. Therefore, in order to gather necessary,
valid and reliable information regarding credit risk management practice of CBE the
sample selected was risk expertise, expert credit analyst, corporate credit managers, credit
administration, risk management, credit appraisal, loan recovery department and
customer relationship managers and consumer loan in the organization.

3.6. Data analysis

All data collected in this research was analyzed using descriptive statistic technique.
Thus, percentage and frequency count and table was used to analyze data collected by
both primary and secondary data by using SPSS.
 Chapter four
4. Data Analysis, Finding and Discussion

4.1. Data Analysis

This chapter presents analyzed results and interpreted discussions of the data obtained
from the primary source as well as secondary sources. The primary data was obtained
from the questioners which are designed to collect the necessary data to answer the
research questions. The questionnaires are administered for one hundred and ten
respondents from all sections of credit and risk management department of Commercial
Bank of Ethiopia both at head office and district level. Secondary data was obtained from
annual reports in order to show the progress of NPL of loan dispersed to different
economic sector and credit policy and procedures in order to know the extent of
implementation. Hence all data collected from primary data as well as secondary data
was analyzed.

4.2. Results of data gathered from questionnaire

This part has six sections in relation to data of questioners. The first section deals with
the demographic data of respondents. The second section deals with credit risk level of
loan dispersed to different economic sectors. An internal and external factor that
challenges implementation of credit risk management policy of the organization and
factors facilitate increase NPL level of the bank are presented in third and fourth section
respectively. Fifth and sixth section deals with tools and techniques of credit risk
management used by the organization and its credit risk mitigation mechanism
respectively.
4.3. Background information of respondent and validity, reliability
and ethical issues

One hundred and ten questionnaires was distributed to the respondent and out of one
hundred and ten questionnaires 106 of them was collected 4 of them are not collected
with a response rate of 96%. The research is study is reliable since the respondent was
selected based on their duty and responsibility and their past experience on credit
management and appraisal, credit analyst expert, credit administrator, loan recovery
department and risk management expert those directly attached to credit activities and
their answer was expected to be reliable. Moreover, the research analysis takes into
consideration not only finding from the primary data but also secondary data have also
been gathered and interpreted. Secondary data which are officially published sources and
which cannot be manipulated by the researcher as well as by respondent i.e. annual
reports, credit policy and procedure. The demographic characteristic includes job title,
level of education, field of specialization and work experience. Table 1 to table 4 below
shows details of background information of respondent. Due consideration is given to
obtain consent from each participant about their participation in the study. It was
conducted on voluntary bases the researcher tries to respect the participant right and
privacy. The finding of the research was presented without any variation from the
outcome of the research. In addition the research full acknowledgment to all reference
material used in the study.

Table 1: frequency distribution of respondent by level of education

Educational level Frequency Percent

Master Degree 45 42.5

Degree 61 57.5

Source: survey and SPSS frequency out put

Regarding the respondent educational qualification as indicated on above table-1
(42.5%) of the respondents are post graduate degree holder and the rest (57.5%) of
respondents are undergraduate degree holder. the research tries to identifies the
respondent by their educational level in order to know the qualification of the respondent
to analyze weather their response are pertinent. From this it is possible to suppose that the
composition of the respondents include well qualified to explain about the subject matter
of the study.

Table 2: frequency distribution respondent by field of specialization

Field of specialization Frequency Percent

Accounting and finance 44 41.5

Management 33 31.1

CPA 1 .9

Economics 28 26.4

Source: survey and SPSS frequency out put

As shown from the above table-2, 41.5% are studied Accounting and Finance, 31.1%
study Management and the rest 26.4% graduate of Economics. Therefore the
backgrounds of all respondents are from business department and it is possible for them
to understand the term raised on the questionnaires that contributed to validity of the
information they provided.

Table 3: frequency distribution Respondent by current position

Positions Frequency Percent

Expert 28 26.4

Managerial 46 43.4

Professional 32 30.2

Total 106 100.0

Source: survey and SPSS frequency out put

 As shown on the above table -3 from the total respondent 43.4% of them was managerial,
30.2 % professional and the rest 26.4% are experts. Such a segregation of the respondent
is important to suppose the research choose the right professionals which have direct
relationship with the subject matter and in order to gather the necessary information
regarding credit and risk management of the organization.

Table 4: frequency distribution respondent by Work experience

Work experience Frequency Percent

0-5 years 31 29.2

6-10 years 28 26.4

Valid 11-20 years 40 37.7

More than 20 years 7 6.6

Total 106 100.0

Source: survey and SPSS frequency out put

As presented on the above table-4 majority of the respondent (37.7%) have been working
for CBE for 11-20 years and 26.4% of them have been working for the organization for
6-10 years. In general, almost more than half of the respondents have been working for
more than 5 years in CBE, which indicate their long period of experience and that
contribute to both the reliability and validity of the information they offer.

4.4. Credit risk assessment

This section shows survey results regarding credit risk management practice of CBE.
 4.4.1. Level of Credit Risk

Table 5: Level of credit risk on loan category by economic sector.

Economic Sectors No Risk Low Risk High Risk Very High Risk
freq % frequ % frequ % Freque %
age ency age ency age ncy age
Agricultural loan - - 7 6.6 54 50.9 45 42.5
Manufacturing loan - - 59 55.7 43 40.6 4 3.8
Import and export loan - - 30 28.3 68 64.2 8 7.5
Domestic trade and service loan 1 0.9 72 67.9 32 30.2 1 0.9
Building and construction loan 3 2.8 65 61.3 34 32.1 4 3.8
Personal and ESL and mortgage loan 25 23.6 76 71.7 5 4.7 - -

Source: survey and SPSS frequency out put

Table 5 above shows the responses given to indicate the level of credit risk being faced
by the bank on loan category by economic sector. The research asks this in order to know
the type loan on which the bank is highly exposed to credit risk. The result shows that
agricultural loan is 93.4% and Import and export loan 71.7% contain the highest and
second highest level of credit risk as replied by respondent. Currently, the bank provide
loan to three priority sectors (i.e. agricultural, manufacturing and export sector) which
directly attached to the economic development of the country. As the bank is owned by
government the bank is expected to give due attention to the development sector of the
country. According to Wang (2013) find out that, as agricultural producers businesses are
largely depends on weather and because of the unpredictability of natural environments,
the sector is highly exposed to credit risk. The export businesses are also highly affected
by overseas market due to fluctuation in foreign exchange rate. However, the researcher
only point out the mitigation mechanism of credit risk emanated from fluctuation of
exchange rate. According to Solomon (2013) on the study about credit risk management
practice of NIB the research tries to indicate that manufacturing loan have the highest
percentage share from overall credit portfolio of the bank and this leads to high level of
credit concentration risk on single economic sector but the research does not tells us the
risk level of loan dispersed to each sectors on credit portfolio. However, this research
tries to see the levels of risk faced by each sectors in the credit portfolio of CBE and their
contribution to NPL. According to result shown in the above table 5 the two priority
sectors are highly exposed to credit risk according to respondent. This indicates the bank
is highly vulnerable to agricultural loan risk and Import and export loan risk. According
to C.Baker (1998) as indicated on literature review part Credit risk occur when one of the
counter parties to a transaction does not clear up in full either when the fund are
outstanding or on some later date and it may result in bankruptcy of counterparty.
Therefore, the risk exposure of the above two sectors are high and bank excepted to give
due attention and follow up and when loan dispersed to all sectors exceptionally for this
two sectors and should prepare efficient credit risk mitigation mechanisms.

4.5. Credit risk management practice

Table 6: principles of credit risk management used.
Used Not Used
Position
Freq Percent Freq. Percent
Establishing an appropriate credit risk environment 93 87.7 13 12.3
Operating under a sound credit granting process
97 91.5 9 8.5
Maintaining an appropriate credit administration,
97 91.5 9 8.5
measurement and monitoring process
Ensuring adequate controls over credit risk 90 84.9 16 15.1
The role of supervisors 84 79.2 22 20.8

Source: survey and SPSS frequency out put

The success and survival of commercial banks are greatly depending on effective Credit
risk management system and practice (Atakelt & Veni, 2015).According to Basel (2000)
as stated on literature review part financial institution are facing several problems due to
lack of adequate credit risk management principles, proper implementation credit
standards of borrower and counterparties and poor portfolio risk management or a lack of
attention to changes in economic or other circumstances that can lead to a worsening in
the credit standing of a bank’s counterparties. Thus, as shown in the above table 6
(87.7%) respondents agree on the bank impalements Basel (2000) principles of
establishing an appropriate credit risk environment, (91.5%) operating under a sound
credit granting process, (91.5%) for maintaining an appropriate credit administration,
measurement and monitoring process, (84.9%) ensuring adequate controls over credit
risk and (79.2%) role of supervisors. Thus, the bank uses all principles of credit risk
management principles stated on Basel (2000) for enhancement of its credit risk
management system. According to Desalegn (2013) on his study on risk management in
Ethiopian commercial banks find out the importance of establishing a formal risk
management structure and developing written policy and procedure create effective risk
management. Wang (2013) identified eight major expectations for a sound credit risk
management models in China RCBs, including comparable, integrated with other risk
management models, based on existing and available data, practical-based, quantitative
and qualitative combined, easy to use, adaptable to changes and simple and straight
forward. Bajpai et.al. (2015) confirmed that on the study done on Assessing Credit Risk
Management Practices and Performance of Commercial Banks in Rwanda, BPR Ltd has
put in place a very strong credit risk management to ensure that loans are granted and
managed effectively and efficiently. Singh A. (2013) discussed on Credit Risk
Management Policy of Indian commercial banks that dictates the Credit Risk Strategy.
These policies spell out the target markets, risk acceptance/avoidance levels, risk
tolerance limits, prefer levels of diversification and concentration, credit risk
measurement, monitoring and controlling mechanisms of Indian commercial banks.
 4.6. Challenges in effective implementation of credit risk
management policy

Table 7: internal factors and CRM policies of the bank

Internal Factors Very Highly Least Not
Highly challenging challenging challenging
challenging
Freq % Fre % freq % Fre %
age q age age q age
High cost of information technology. 9 8.5 59 55.7 31 29.2 7 6.6
Lack of technical knowledge. 23 21.7 50 47.2 24 22.6 9 8.5
Lack of training within the organization about CRM. 19 17.9 56 52.8 23 21.7 8 7.5
Lack of employee’s motivation to implement. 16 15.1 31 29.2 43 40.6 16 15.1
Difficult to understand the policy and procedure. 10 9.4 32 30.2 40 37.7 24 22.6
Access to material related to CRM 9 8.5 47 44.3 43 40.6 7 6.6
Difficulty in quantifying risk 31 29.2 55 51.9 20 18.9 - -
Information gap 48 45.3 43 40.6 13 12.3 2 1.9
Source: survey and SPSS frequency out put

According to Singh (2013) as indicated chapter 2 literature review part that for long term
achievement of banking sector effective credit risk management practice is a vital issue in
the current business environment and poor credit risk management policy will create
serious source of crisis in the banking industry. Solomon (2013) tries to identify the
major challenge of NIB facing in implementation of the credit risk policies of the bank
(NIB) are high cost of information technology, lack of knowledge within the organization
and conflicting business priorities are the major challenging factors in implementation of
credit risk policy of NIB. But the result in this paper shows on the above table 7 are the
major hindrance factor of listed variables on the implementation of credit policy of the
bank are ranked as information gap 85.9%, difficult in quantifying risk 81.1%, Lack of
training within the organization about CRM 70.7%, Lack of technical knowledge 68.9%,
High cost of information technology 64.2%, Access to material related to CRM 54.8%
 Lack of employee’s motivation to implement 44.3% Difficult to understand the policy
and procedure 39.6%. This shows that the bank is expected to file the gap by overcoming
the challenges in order to insure effective implementation of the policy at all level credit
department of the bank by taking remedial action in order to improve the gap of
employees. According to Atkilit (2015) discussed in chapter two effectiveness of credit
risk management process is dependent on different variables such as proper application of
best Risk management documents, Staff quality, Credit culture, devoted top management
bodies, sufficient training program, proper organizational structure, ample level of
internal Control and Performance of intermediation function. Desalegn (2014) states the
most difficulties that the banks are currently facing in managing risk are: lack of
adequate, weak information management system, lack of competent and experienced
staff, lack of exposure to the outside world and lack of awareness about the concept of
risk management due to its newness in the institutions. Bajpai et.al. (2015) find out that
the effective implementation of credit risk management affects profitability of
commercial banks in Uganda. The researchers further indentified that the challenges of
credit risk management implementation in the Ugandan commercial banks are the
following: Insufficient skills of some of credit risk managers in managing risks,
Continuous changes in Rwandan market which destabilize market factors and thus bring
default risk and Clients are not professional enough to carry on their business effectively
in order to pay back credit given by commercial banks

4.7. External factor and the effectiveness of CRM

Table 8: external factors and CRM of the bank
Macro factor Positively Affect Negatively Affect Both Pos & Neg Affect Do Not Affect

Freq % age Freq % age Frequency % age freq % age

Government policy 55 51.5 24 22.6 21 19.8 6 5.7
Infrastructure facility 59 55.7 26 24.5 11 10.4 10 9.4
Background of the society 41 38.7 39 36.8 17 16 9 8.5
Level of Economy 48 45.3 37 34.9 18 17 3 2.8
Global economic crisis 22 20.8 61 57.5 15 14.2 8 7.5
Source: survey and SPSS frequency out put
As shown on the above table 8 all external factors have positively affect the bank credit
risk management practice with percentage of 51.5% government policy, 55.7%
infrastructural facility, 38.7% background of society and 45.3% level of economy but
negatively affected by global economic crises 57.5% according to the respondent. Since,
the bank is owned by government the policy and strategy drawn by government supports
the bank credit policy. On the other hand, the bank is extending its branch inside and
outside the country by providing different credit products for its customer which creates
exposure to global economy. For example export and import credit facility. So the bank
expected to consider the global economic situation during loan approval process. Wang
(2013) states on his research that, in China the government dominates the economy and
the government has frequently changed its policy such as credit policy, financing policy
for Sannong, rural development, housing policy and so on. When those policies change,
many SMEs have to bear the consequences of these changes; some gains and some
losses. This is going to affect the credit risk management practice of china commercial
banks. In addition to this the main external environmental triggers include, among others,
globalization of markets and the internationalization of business, major economic,
political and social events, technological advancements, customer expectations, supplier
requirements, increasing competition, organizational growth, and fluctuations in business
cycles are raised in China RCBs. According to survey conducted by Solomon (2013) on
NIB bank, the bank is negatively influenced by the government policy and infrastructural
facility 45% and 44% respectively.
 4.7. Factors Contributing for Occurrence of NPL

Table 9: the extent of Factors contributing for occurrence of NPL in the bank.

Most Important Important Least Important Not Important

Freq % age Freq % ag freq % age freq % age
Interest rate 15 14.2 10 9.4 42 39.6 39 36.8
Poor credit assessment technique 46 43.4 38 35.8 19 17.9 3 2.8
Size of the institution or the bank 8 7.5 31 29.2 36 33 32 30.2
Ownership type 17 18 46 43.4 34 32.1 9 8.5
Knowhow of employees 28 26.4 35 33 38 35.8 5 4.7
Credit culture of the society 52 49.1 32 30.2 21 19.8 1 0.9
Know your customer (KYC) principle 62 58.5 31 29.2 11 10.4 2 1.9
Growth of loan demand. 22 20.8 46 43.4 33 31.1 5 4.7
Lack of follow up by credit department 46 43.4 48 45.3 11 10.4 1 0.9
Diversion of the loan for other 53 50 33 31.1 14 13.2 6 5.7
activities
Behavior of the customer 56 52.8 40 37.7 10 9.4 - -
Time duration of loan 20 18.9 68 64.2 13 12.3 5 4.7

Source: survey and SPSS frequency out put

Currently Commercial Bank of Ethiopia (CBE) provides different type of credit product
as indicated on the background part of this study. the bank is one of the largest bank in
terms of financial as well as non financial capitals in Ethiopia so the increase in level
different type of credit product will create suitable environment for the increment of NPL
unless the bank properly manage factor causing the occurrences of nonperforming loan.
According to Solomon (2013) point out that the major contributing factors for the
increment of NPL in NIB bank are poor risk assessment, poor monitoring/follow-up,
credit culture and relaxed credit terms. Bajpai et.al. (2015) find out the causes for the
increase in NPL of the commercial banks in Uganda are Poor credit risk management,
 Poor credit analysis, Economic development of the country, Unsuccessful financed
project and Unsuccessful financed project were listed as the major one. The researcher
also shows that mismatch of the bank’s assets and its profitability was caused by many
factors including high rates of NPLs. In addition to this poor management of credit risk
led to an increase of NPLs which lead to increase of bad debts provision and finally
reduces profitability. Thus, if the credit policy is not effectively implemented the banks’
profitability will be adversely affected.
As shown in the above table 9 all factor have their own contribution for the increment
level of NPL but know your customer (58.5%), behavior of the customer(52.8%),
diversion of loan for other activity(50%) and credit culture of the society (49.1%) are the
grand factor for the occurrences of NPL. Poor credit assessment techniques, Ownership
type, knowhow of employee, growth of loan demand and time duration of loan also have
unquestionable impact according to respondent. The bank must know by whom the loan
is requested and its relationship with a bank, its behavior, types of business (legal or
illegal), its capacity to repay, negative record on other loan repayment and 5C ( capacity,
capital, character, condition and collateral) were followed before and after loan approval
in order to minimize NPL level.

4.8. Factor of credit granting process

Table 10: the importance of factors considered in credit granting process in the bank.
5Cs Most Important Important Least Important Not Important

Freq % age Freq % age freq % age Freq % age

Character 75 70.8 26 24.5 2 1.9 3 2.8
Capital 47 44.3 57 53.8 2 1.9 - -
Collateral 41 38.7 34 32.2 29 27.4 2 1.9
Capacity 77 72.6 20 18.9 3 2.8 6 5.7
Condition 48 45.3 45 42.5 12 11.3 1 0.9

Source: survey and SPSS frequency out put

As discussed on the literature review parts of the study different scholars point out that in
order to operate on sound credit granting process the implementation of the above listed
5C plays important role.
As result on table 10 above shows all 5C are highly used in credit granting process of
Commercial Bank of Ethiopia. Capacity to repay (72.6%), characteristics of the business
and owner (70.8%), conditions of borrower (45.3%), capital of the borrower (44.3%) and
collateral (38.7%) used respectively according to respondent. Even if the bank uses
capacity or ability to pay and willingness to pay as major point the bank must also give
due attention to collateral in the credit granting process as risk mitigation mechanism
because Collateral is an asset that serves as security against counter party risk. Anderson
& Joeveer(2014). Mark K. (2010) Find out, the extent that capacity/competition and
conditions are mostly used as in screening and risk analysis before awarding credit to
clients. It was further found that extent that collateral/security and character of borrower
were used in screening and risk analyses before awarding credit to clients are moderate
impact in financial institutions in Kenya.

4.9. Advisory service to credit customer

Table 11: Response to advisory service to credit customer

Advisory service Frequency Percent

Yes 96 90.6
Valid No 10 9.4

Total 106 100.0

Source: survey and SPSS frequency out put

As indicated on the above table 11 96% of respondent confirmed that there is type of
advisor service to credit customers such as technical and financial aspect of proposed
business entity and about loan process.
 4.10. Credit risk measurement techniques
Table 12: Extent Credit scoring technique used by the bank
Credit Score Most Important Important Least Important Not Important
Freq % age Freq % Freq % age Freq % age
age
Marketing score 50 47.2 42 39.6 7 6.6 7 6.6
Application score 37 34.9 40 37.7 24 22.6 5 4.7
Fraud score 36 34 41 38.7 22 20.8 7 6.6
Performance score 55 51.9 38 35.8 12 11.3 1 0.9
Behavioral score 58 54.7 35 33 9 8.5 4 3.8
Early warning score 47 44.3 39 36.8 14 13.2 6 5.7
Collection score 46 43.4 48 45.3 9 8.5 3 2.8
Profit score 40 37.7 54 50.9 10 9.4 2 1.9

Source: survey and SPSS frequency out put

As shown in the above table 12 all respondent uses all credit scoring stage in order to
measure the risk level of the business to make decision in the credit approval process.
Behavioral score, Marketing score, Early warning score, Performance score, Collection
score, Application score, Profit score and Fraud score with 47.2%, 34.9%, 34%, 51.9%,
54.7%, 44.3%, 43.4% and 37.7% respectively used most importantly by the respondent.
This helps the bank to properly assess, analyze and decide on credit process.
According to Beasens and Gestel (2009) as discussed on chapter two Credit scoring is a
credit risk management technique that analyzes the borrower’s risk and used to assess
and decide, who will get credit, how much credit they should get, and what operational
strategies will enhance the profitability of the borrowers to the lenders.
According to Zaidi & Samareen (2012) uses demographic factor(Gender, Client's locative
situation , Education level, Proximity towards bank branches, Marital status, Age, No. of
dependents, Loan tenure, Occupation, Working period with the last employer, Working
period with the current employer, Loan period, Banking references at Bank, Monthly net
income of the applicant, Credit History and Loan from other banks) as a means of
measuring the credit worthiness of the individual borrower in Pakistan commercial banks.
As stated by researchers all factors have their own contribution on estimation or
 prediction of the creditworthiness of individual borrower when we assess the credit score
(CSMI) from this the most important factor that must be considered is the credit history
of the applicants those borrowers who have defaulted previously can be predicted to
default in the future. However, the researchers consider only applicant score they don’t
consider the other scoring factor. Abdou, El-Masry & Pointon (2007) analysis that those
applications that have been accepted, some of which later proved to be bad. Of course,
some of the initially rejected applications may have led to recommendations of
acceptance. Some of the predictor variables have not normally been used in published
studies of credit scoring models, for example: corporate guarantee, branch, and loans
from other banks. There are particularly appropriate within the Egyptian environment.

4.11. Credit risk model

Table 13:Credit risk models used in the bank.
Frequency % age
Value at risk model 14 13.2
Credit metrics model 9 8.5
Altman’s z-score model - -
Merton-based models 6 5.7

Source: survey and SPSS frequency out put

As shown in the above table 13 most of the respondent does not specify the credit risk
model used by their bank. Credit Risk model deals with the understanding and prediction
of risk levels. Beasens & Gestel (2009). The researcher advices the banks to adopt those
models to assess and predict the credit risk level. However, the bank developed other risk
rating or grading according to respondent to predict the risk level of the business. Grade-
1 risk are exceptionally low risk (bankable), Grade-2 risks are very low risk(bankable)
but higher than grade-1 risk, Grade-3 risk are low risk(bankable), Grade-4 risks are
moderate risk(bankable), Grade-5 risks are potential risk (exceptionally bankable),
Grade-6 risk are high risk(very exceptionally bankable), Grade-7 risk are very high risk
 (not bankable) and Grade-8 risk are default risk(not bankable) as stated on (Commercial
Bank of Ethiopia credit procedure 2013). According to Desalegn (2014) the Ethiopian
commercial banks uses combination of quantitative and qualitative tools of risk
measurement tools such as statistical tools, analytical tools, scenario analysis, value at
risk and using experience and intuition.
According to the finding of Wang (2013) on chine rural commercial banks there are
problems of complications on credit risk management models and lacking of data, so
RCBs are expected to develop their own credit risk management system and model. The
researcher further elaborate that the problem of existing models that was mainly based on
the data from an advanced market economy exclusive of localities in a particular
economy like China where capital market is still in the development stage and the
government domination in the economy is strong. The training given to employees are
mainly focus on the theories of quantitative evaluation models such as logistic,
regression model, ZETA model which doesn’t focus on how to use and implement on
their own banks. The existing model also does not take into account macro-economic
policy from the top level government instead the existing models are too micro and
market focused and they ignore the policy impact. However, The researcher do not
discuss on how to modify and simplify their training on credit risk management models
applied in chine rural commercial banks in order to reduce the complexity of the models.

4.12. Activity performed to reduce credit risk

Table 14: level of listed Activities used in order to reduce credit risk by the bank.
Highly used Used Least Used Not Used
Freq % age Freq % age Freq % age freq % age
Develop MIS 63 59.4 36 34 7 6.6 - -
Periodic credit calls 39 36.8 34 32.1 30 28.3 1 0.9
Periodic visits of borrowers 60 56.6 39 36.8 5 4.7 2 1.9
Credit risk rating 66 62.3 31 29.2 9 8.5 - -
Annual review of accounts 45 42.5 48 45.3 12 11.3 1 0.9
Risk scoring 59 55.7 38 35.8 9 8.5 - -

Source: survey and SPSS frequency out put

 The table 14 above shows the level of activity used by the bank in order to reduce the risk
level of credit product. This question is asked by researcher in order to investigate the
level of activities performed by bank in order to minimize the credit risk level. According
to the respondent 62.3% Credit risk rating, 59.4% develop MIS, 56.6% Periodic visits of
borrowers, 55.7% risk scoring, 91.5% and are highly used mechanism above 50%.
Annual review of account 42.5% and Periodic credit calls 36.8% are highly used but
relatively below 50%. A study done on NIB bank shows development of MIS given list
attention according to Solomon (2013). But this study justifies in Commercial Bank of
Ethiopia there is no problem in development of MIS instead the bank gives least attention
to annual review of accounts is very important factor because it is directly attached to
know your customer principle reviewing the customer account tell the current status of
the customer and it can help us to follow up the borrower. Predict credit call also help us
to the current status of the customer business. So the bank has to give attention to these
two important issues.

4.13. Credit risk management process

Table 15: credit appraisal
Credit Appraisal Strongly Agree Neutral Disagree Strongly
Agree Disagree
Fre. % Fre. % Fre % freq % freq %
There is credit policy and procedure with 58 54.7 34 32.1 10 9.4 3 2.8 - -
clearly stetted eligible criteria.
There is independent risk management 8 7.5 14 13.2 11 10.4 29 27.4 44 41.5
policy and procedure from credit policy and
procedure in your organization.
There are time credit granting and 13 12.3 37 34.9 21 19.8 14 13.2 21 19.8
monitoring process is overridden by
directors, senior management influential
staffs
The bank carried out credit processing 32 30.2 35 33 5 4.7 16 15.1 18 17
activities independent of appraisal function
The bank checks the borrower history 64 60.4 38 35.8 2 1.9 1 0.1 1 0.1
before granting loans
Credit granting approval process establish 50 47.2 45 42.5 6 5.7 4 3.8 1 0.1
accountability for decision taken
The bank properly assessed the customer 59 55.7 39 36.8 7 6.6 1 0.1 - -
ability to meet obligation
Source: survey and SPSS frequency out put

As shown above on table 15 the bank has clearly stated credit policy and procedure with
eligible criteria expected to be fulfilled by borrower when they need credit facility from
the bank. However, the bank does not have independent risk management policy and
procedure from credit policy and procedure instead it is included on credit policy and
procedure.
Credit appraisal is a process of investigating borrower’s background history and
sustainability of income of its business by using 5C’s. The researcher asks the above
questions in order to know the effectiveness of credit appraisal techniques. As shown in
the above table 15 the respondent agree (86.8%) in statement that the bank has credit
policy and procedure with clearly stated eligible criteria expected from borrower which
maximize the effectiveness of credit risk management process.
With regard to the statement there is independent risk management policy and procedure
from credit policy and procedure in your organization (79.3%) of respondent disagreed.
The absence of independent risk management policy and procedure hinders the
effectiveness of the appraisal process as well as overall risk assessment process which
finally create an opportunity for the increment of NPL of the bank in the long run.
The survey tells us (47.2%) of respondent agree that there are time credit granting and
monitoring processes are overridden by directors, senior management influential staffs
33% disagree 19.8% neutral. the bank should avoid the interference of higher level
manger in the credit process except the exception stated in the credit policy and the bank
could clearly state segregation of duties within the credit structure of the bank unless the
bank is highly exposed to fraudulent action which facilitate way to NPL.
From the total respondent 63.2% agree with statement that the bank carried out credit
processing activities independent of appraisal function this shows that there is check and
balance or “four eyes principle” in the credit process which is the best practice of the
bank in order to manage the credit risk.
 96.2% of respondent also agree that there is accountability in the decision taken in the
credit granting process. The existence of accountability will minimize the negligent act of
staff member which is involved in the credit approval decision.
The investigations with regard to assessment on customers’ ability to meet their
obligation 89.7% of respondent agree that there is proper assessment technique used by
the bank in order to know the borrower’s ability to meet their obligation. Thus, the bank
should continue its best practice of assessment techniques. Desalegn (2014) identified
most recognized method used to identify risk is auditing or physical inspection, product
portfolio analysis, experimentation of past experience are the three important method.
Brain storming and process mapping and workshop also recognized as risk identification
methods. The research shows the overall risk identification method but the research
doesn’t tell the individual risk identification method. Solomon (2013) shows on his study
NIB bank have adequate policy procedure and defined credit granting criteria and the
bank lend by properly checking the borrowers history. The bank does not have clear risk
measurement and evaluation approach and the research don’t indicate whether the bank
has independent credit risk management policy and procedure with credit policy and
procedure.
Table 16: credit administration
Credit Administration Strongly Agree Neutral Disagree Strongly
Agree Disagree
Fre % Fre % Fre % freq % freq %
q. age q age q. age age age
The bank has well structured documentation 39 36.8 50 47.2 10 9.4 3 2.8 4 3.8
tracking system for credit and collateral
files
The process of credit administration is 16 15.1 20 18.9 22 20. 21 19. 27 25.
performed independently of individual 8 8 5
involved in the business organization of
credit

Source: survey and SPSS frequency out put

As shown on the above table 16 from the total respondent’s 84% agrees on the statement
that the bank has well structured documentation tracking system for credit and collateral
files. In the credit process from appraisal to dispersement level a well structured
 document tracking system is needed in order to simplify the tracing process. So the bank
has a proper document tracking techniques which is highly appreciated.
The investigation with related to the process of credit administration is performed
independently of individual involved in the business organization of credit 45.3% of
respondent disagree with the statement. This indicate that the credit administrator
separately perform its activity from the individual involved business organization of
credit.
Table 17: monitoring control of credit
Monitoring Control of Credit Strongly Agree Neutral Disagree Strongly
Agree Disagree
Fre. % Fre % Fre % freq % freq %
age q age . age age age
The bank regularly undertake stress testing 35 33 38 35.8 14 13.2 14 13.2 5 4.7
on overall credit portfolio
Collateral coverage is regularly assessed 49 46.2 42 39.6 8 7.5 6 5.7 1 0.9
and related to the borrowers financial health
The banks periodically prepare credit 44 41.5 46 43.4 14 13.2 2 1.9 - -
quality report for warning sign loan loss in
any portfolio.
The bank monitor the business of client 44 41.5 36 34 13 12.3 12 11.3 1 0.9
after granting credit on regular bases
Customer are often given sufficient training 14 13.2 10 9.4 12 11.3 44 41.5 26 24.
on loan usage 5

Source: survey and SPSS frequency out put

Credit monitoring and controlling process is the main point in the credit granting process
because every loan must be monitored and controlled by the lender or the bank with
proper monitoring and controlling mechanism.
As shown on the above table 17 (68.8 %) of respondent agrees with the statement that the
bank regularly undertake stress testing on overall credit portfolio. The bank tests the
stress of borrowers in order to make remedial action on the spot.
From the total respondent 85.8% of them agreed that collateral coverage is regularly
assessed and related to borrowers’ financial health. This process will create the mitigation
mechanism simple and the bank keeps on doing that.
 In the statement the banks periodically prepare credit quality report for warning sign loan
losses in any portfolio 84.9% of respondent agree. This shows that the credit quality is
checked properly and it create good environment for credit risk management.
Large percentage (75.5%) of respondent also agreed on after granting credit on regular
bases the bank keeps an eye on the business of client. This can help the bank to know the
status of the business and repayment capacity and willingness of borrowers.
The survey brought out that 66% of respondent disagree with the statement that
Customers are often given sufficient training on loan usage. This shows that there is no
training facility for borrower on how to use the credit disbursed which create ground for
loan diversion to other sector instead of using for the proposed purpose. Thus, this
situation creates complexity in credit risk management process. Therefore, the above
issues except customers are given sufficient training on loan usage the bank have best
practice that other bank learns from it.
According to Desalegn (2014) the risk management policy, procedure and limit are
adequate to identify, measure, monitor and control risk of banks. It should have well
established internal control system, which includes segregation of duties, clear
management reporting lines and adequate operating procedure. The finding on
monitoring and controlling of credit, Solomon (2013) concluded that there is no proper
functioning monitoring and controlling of credit in NIB bank.

Table 18: Managing loan recovery.

Managing Loan Recovery Strongly Agree Neutral Disagree Strongly
Agree Disagree
Fre. % Fre Freq % % Freq % freq %
age q age age age age
The bank has appropriate criteria for credit 56 52.8 48 45.3 1 0.9 - - 1 0.9
classification provisioning and write off
The bank has loan recovery procedure that 65 61.3 35 33 3 2.8 2 1.9 1 0.9
clearly set out how problem credit is to be
managed.
Adequate measures are put in place to 58 54.7 46 43.4 1 0.9 1 0.9 1 0.9
recover nonperforming loans

Source: survey and SPSS frequency out put

Non-Performing Loans (NPLs) shall mean bad debts as defined in the Directives of the
National Bank of Ethiopia. In order to independently manage these loans, the Loan
Recovery Team was established primarily entrusted to protect the interest of the Bank.
As shown in the above tables large number of respondent agrees on the bank has
appropriate criteria for credit classification provisioning and write-off. This manifest the
bank has a well stated credit classification and write-off criteria in order to collect NPL.
Most of the respondent about 94.3% agrees on statement that the bank has loan recovery
procedure that clearly set out how problem credits are to be managed. As stated on loan
recovery procedure the bank have independent loan recovery department that deal on
credit problem of the bank. Thus, the bank has a well organized loan recovery department
that stand for the benefit of the bank.
From the total respondent 98.3% of them agree on the existence of adequate measures to
recover nonperforming loans. This clearly stipulates that the bank has adequate
measurement criteria to recover from NPL.
Loan recovery mechanism of the bank
The bank has well structured loan recovery procedure to recover from non performing
loans. As stated on loan recovery procedure 2013 basically there are three types of
recovery loan follow-up systems, which the Loan Recovery Officer is expected to
perform. These are:
i. Physical Follow-Up
ii. Financial Follow-Up, and
iii. Legal Follow-Up

i. Physical Follow-Up
Physical follow-up helps to ensure existence and operation of the business, status of
collateral properties, correctness of declared financial data, quality of goods,
conformity of financial data with other records (such as VAT/excise taxes, register
books), availability of raw materials, labor situation, marketing difficulties observed,
undue turnover of key operating personnel, change in management set up, etc.
2.10.1.2 Financial Follow-Up
1. Financial follow-up is required to verify whether the assumption on which the
restructuring decision was taken continues to hold good both in regard to
borrower’s operation and environment.
2. The concerned Loan Recovery Officer has to make strict and continuous follow-up
on each customer’s loan account performance and reports to the Manager – Loan
Recovery Team and forwarded to the Manager – Credit Research and Portfolio
Management Team on regular basis for overall bank-wide consolidation.

2.10.1.3 Legal Follow-Up

1. The purpose of legal follow-up is to ensure that the legal recourse available to the
Bank is kept alive at all times. It consists of obtaining proper documentation and
keeping them alive, registration, and proper follow-up of insurances.
2. The Loan Recovery Officer and the Attorney are jointly responsible for legal
follow-up.
3. Some of the major legal follow-up issues include:
i. Whether contracts are properly executed by appropriate persons and
documents are complete in all aspects
ii. Obtaining revival letters in time (revival letter refers to renewal letter for
registration of security contracts that have passed the statutory period as laid
down by the law).
iii. Ensuring loan/mortgage contracts are updated timely.

4.14. Credit risk management tools and techniques

Table 19: tools and techniques of credit risk management
Used Not Used
Freq. Percent Freq. Percent
Collateral 103 97.2 3 2.8
Risk rating 85 80.2 21 19.8
Loan recovery /healing 93 87.7 13 12.3
portfolio management 90 84.9 16 15.1
Credit approval authority 83 78.3 23 21.7
Diversification 26 24.5 80 75.5
Source: survey and SPSS frequency out put
According to survey collected and shown on the above table 19 all techniques are used in
the bank as credit risk management techniques except diversification technique. Thus,
collateral 97.2 % in the first place and 80.2%, 87.7%, 84.9%, 78.3%, and 24.5% risk
rating, loan recovery, portfolio management, credit approval authority and diversification
respectively according to their usage in the bank. Diversification is used as least level in
credit risk management practice of the bank. In order to create effective credit risk
management techniques the bank is expected to use all component of credit risk
management techniques.

4.15. Risk reporting

Table 20: risk reporting Schedules

Report Frequency Valid Percent

Quarterly 40 39.6

Valid Annually 24 23.8

Monthly 37 36.6

Source: survey and SPSS frequency out put

According to Desalegn (2014) the risk report should provide a forward looking
assessment of risk shouldn’t rely on past data. The report should contain forecasts or
scenarios for key market variables and the effect on the bank so as to inform the board
and senior management of the likely trajectory of the banks risk profile in the future.
Accurate, timely and complete data is a foundation for effective risk management.

As shown above on table 20 the respondent indicated that 39.6% quarterly, 36.6%
monthly, and 23.8% annually. This result shows that there is no regular and uniform risk
reporting period in the bank which creates difficulty in estimating periodic status of the
creditor or borrower. In order to properly monitor and control the creditor predict status
and to know the NPL level in the credit portfolio the bank should establish effective and
regular credit risk reporting schedule to all level of the employee working on credit.
4.15. Risk mitigation mechanism
Table 21: Credit risk mitigation techniques

Frequency Valid Percent

YES 99 98.0
Valid
NO 2 2.0

Source: survey and SPSS frequency out put

As discussed in chapter two Dohnal (2008) defined Credit Risk Mitigation as a

mechanism used by different credit institution in order to minimize their credit risk
related with exposure which the institution continuous to hold.
As shown in the above table 21 the bank the bank uses collateral as the best way of credit
risk mitigation techniques. About 99% of respondent answer ‘yes’ for the statement does
the bank demand collateral before granting the loan? This question is asked by the
researcher in order to know for what type of loan and by what criteria the bank lend its
credit product. As stated on chapter two literature review part Collateral is an asset that
serves as security against counter party risk. Anderson and Joeveer (2014). Collateralized
credit exposures must have a risk biased exposure amount less than the same credit
exposure without credit protection. The collateral can be in the form of real estate,
receivable and other form of physical collateral Dohnal (2008). Thus, the bank request
collateral for all type of loan to mitigate its credit risk based on the credit risk rating or
grading the risk level for loan Grade 1and 2 minimum 75% collateral required by the
bank for loan Grade 3 (85%) collateral required and for loan Grade 4and above 100%
collateral is required for all type of loan except revolving per shipment export credit
facility under clean bases. Collateral is not necessarily used as primary concern rather it
is secondary way of risk mitigation according to respondent and clearly stated on CBE
credit procedure (Commercial Bank of Ethiopia credit procedure 2013).
 4.16. Secondary data analysis

In order to further analyze the credit risk management practice of the bank data on total
loan and non performing loan was used and discussed. Thus, this part deal with the actual
operation results of credit activity. The bank provides different kind of loan facility to
different economic sector for both governmental and private businesses by prioritizing
sectors as shown below:

Table 22: total loan and NPL level of different economic sector and beneficiary.

COMMERCIAL BANK OF ETHIOPIA

MANAGEMENT INFORMATION SERVICE
NON-PERFORMING LOAN BY ECONOMIC SECTOR AND BY BENEFICIARY

Economic Sector ('000 Birr)

June June June June June
SECTORS 2011 2012 2013 2014 2015

Agriculture 22,357 42,559 164,998 141,320 126,115

Manufacturing 85,577 160,738 591,280 552,145 248,318

Dom. Trade & Services 56,798 75,319 83,993 98,621 234,628

Foreign Trade 94,252 87,563 518,908 327,085 358,706

EXPORT 69,728 75,143 508,757 316,945 336,120

IMPORT 24,525 12,420 10,151 10,140 22,586

Bldg & Construction 21,774 42,035 172,053 130,947 53,122

Personal & Emergency Staff Loan &
mortgage loan 12,611 22,136 35,912 22,627 966,983
Co-finance of Projects

TOTAL NPL 293,370 430,351 1,567,143 1,272,746 1,987,873

TOTAL LOANS 34,217,686 58,326,982 70,432,283 89,665,182 111,435,273

 ('000 Birr)
June June June June June
BENEFICIARIES 2011 2012 2013 2014 2015

PRIVATE 249,640 401,190 1,097,232 795,727 1,947,989

PUBLIC 39,436 26,545 466,193 475,416 33,412

COOPERATIVES 4,293 2,617 3,719 1,603 6,471

TOTALS 293,370 430,351 1,567,143 1,272,746 1,987,873

Source: MIS report 2015

As shown on the above table 21 the NPL status of the bank is below the NBE directive
but it shows an increasing the past five consecutive years. The NPL amount emanated
from various sector and beneficiaries discussed below:
Agricultural sector increases from birr 22,357 million in amount in 2011 from the
total loan dispersed birr 34,217,686 billion to birr 126,115 million in 2015 from
the total loan dispersed birr 111,435,273 billion.
Manufacturing sector birr 85,577 million in amount in 2011 from the total loan
dispersed birr 34,217,686 billion to birr 248,318 million in 2015 from the total
loan dispersed birr 111,435,273 billion.
Domestic trade & services birr 56,798 million in amount in 2011 from the total
loan dispersed birr 34,217,686 billion to birr 234,628 million in 2015 from the
total loan dispersed birr 111,435,273 billion.
Export sector birr 69,728 million in amount in 2011 from the total loan dispersed
birr 34,217,686 billion to birr 336,120 million in 2015 from the total loan
dispersed birr 111,435,273 billion.
Decreases from import sector birr 24,525 million in amount in 2011 from the
total loan dispersed birr 34,217,686 billion to birr 22,586 million in 2015 from
the total loan dispersed birr 111,435,273 billion.
 Building and construction sector birr 21,774 million in amount in 2011 from the
total loan dispersed birr 34,217,686 billion to birr 53,122 million in 2015 from
the total loan dispersed birr 111,435,273 billion.
personal, emergency staff loan and mortgage loan sector birr 12,611 million in
amount in 2011 from the total loan dispersed birr 34,217,686 billion to birr
966,983 million in 2015 from the total loan dispersed birr 111,435,273 billion.
Private sector birr 249,640 million in amount in 2011 from the total loan
dispersed birr 34,217,686 billion to birr 1,947,989 million in 2015 from the total
loan dispersed birr 111,435,273 billion.
Public sector birr 39,436 million in amount in 2011 from the total loan dispersed
birr 34,217,686 billion to birr 33,412 million in 2015 from the total loan
dispersed birr 111,435,273 billion.
Cooperatives sector birr 4,293 million in amount in 2011 from the total loan
dispersed birr 34,217,686 billion to birr 6,471 million in 2015 from the total loan
dispersed birr 111,435,273 billion.

Therefore, the major contributor for the increment of the NPL of Commercial Bank of
Ethiopia is come from private sector as shown in the above table. Thus, the bank could
manage the credit risk level of loan processed to private sectors by using different risk
measurement models, proper follow-up mechanism by visiting the business status and by
creating effective mitigation mechanism in order to predict the future business conditions
of borrowers and to minimize loss.
 Chapter five
5. Summary of findings and Recommendation

In this chapter, a conclusion of the research findings that has been discussed and analyzed
in detail in the previous chapters is briefly presented. In addition, general conclusions that
are highly related with the research objective of this paper are offered. Furthermore,
possible recommendations based on the findings are made.

5.1.1. Summary of findings

Based on the findings, the following conclusions are drawn.

As the bank is becoming large in terms of financial and non financial capacity and owned
by the government it is expected to finance the government project and focus on
developmental sector of the country. Depend on this the bank have three priority sectors
(i.e. Agriculture, Export and Manufacturing sector) of credit facility. As the finding
shows that agricultural loan and import and export loan are highly exposed to risk. The
study result also shows that the NPL of the bank was increasing in the past five
consecutive years from 293,370,000.00 birr in year 2011 to 1,987,873,000.00 birr in year
2015. Hence, unless the bank gives especial attention to these two sectors the NLP level
will increase in the long run.
The study result also illustrate that the bank has well organized credit policy and
procedure that state duty and responsibility of all department with clearly stated
eligibility criteria expected from borrower for all types of credit product facilitated by the
bank. In the bank procedure credit appraisal expert and customer relationship managers
do their activity independently in order to insure “four eyes principle” or check and
balance by creating single point of contact with the customer and customer relationship
manger. However, the result shows that the bank does not have independent risk
management policy and procedure from credit policy and procedure instead it is included
on credit policy and procedure. This could create a multifaceted credit risk management
process.
The study demonstrates the bank uses different credit risk mitigation mechanism by
grading the credit risk level. The bank request collateral for all type of loan to mitigate its
credit risk based on the credit risk rating or grading the risk level. If the risk grade of the
loan is Grade 1and 2 minimum 75% collateral required by the bank for loan Grade 3 85%
collateral required and for loan Grade 4and above 100% collateral is required for all type
of loan except revolving per shipment export credit facility under clean bases. Collateral
is not necessarily used as primary concern rather it is secondary way of risk mitigation
tool. The bank also uses 5C (i.e. capacity, capital, character, condition and collateral) as
major risk mitigation techniques in the credit granting process in order to identify by
whom the loan is requested and its relationship within a bank, its behavior, types of
business (legal or illegal), its capacity to repay, negative record on other loan repayment
to minimize the NPL of the bank.
As the result confirm the bank uses different credit risk measurement techniques from
this credit scoring used to properly assess, analyze and decide on credit process by
measuring the risk level. The bank also developed internal risk rating or grading model to
predict the risk level of the business. Grade-1 risk are exceptionally low risk (bankable),
Grade-2 risks are very low risk(bankable) but higher than grade-1 risk, Grade-3 risk are
low risk(bankable), Grade-4 risks are moderate risk(bankable), Grade-5 risks are
potential risk (exceptionally bankable), Grade-6 risk are high risk(very exceptionally
bankable), Grade-7 risk are very high risk (not bankable) and Grade-8 risk are default
risk(not bankable) to determine the amount of collateral required to mitigation the credit
risk.
The result also shows that the bank also adopted the five sound principles of banks credit
risk management establishing an appropriate credit risk environment, operating under a
sound credit granting process, maintaining an appropriate credit administration,
measurement and monitoring process, ensuring adequate controls over credit risk and the
role of supervisors stated by Basel (2000) guideline.

Generally, the bank has good practice in credit risk management from credit appraisal to
the final stages of credit recovery that will be used as benchmark. However, there are
major points recommended by the researcher to fill the gap shown in the finding and to
reduce NLP of the bank.
5.1.2. Recommendations

Based on the above finding and conclusion the researcher forwarded the following
recommendation to the organization.

As indicated above the bank does not have independent risk management policy and
procedure. As the bank is becoming large and complex it needs separated risk
management policy and procedure. Therefore, the bank could develop or adopt
independent risk management policy and procedure in order to build up proper and
effective risk management system.

As indicated on procedure there is single point of contact for customer. This could expose
the credit process to fraudulent activities which finally create credit risk. Thus, the bank
should consider this issue when the procedure reviewed since the procedure is reviewed
every three years.

The bank do not have credit risk model that predict the level of risk originate from the
business instead the bank only uses internally developed risk grading technique.
Therefore, the bank should adopt credit risk measurement models in its credit assessment
process in order to construct effective credit risk management techniques.

The finding indicates that there is no regular and uniform risk reporting period in the
bank which creates difficulty in estimating periodic status of the creditor. Thus, bank
should establish effective and regular credit risk reporting schedule to all level of the
employee working on credit.

As the result from finding shows agricultural and import and export loan have high risk
which directly increase NPL of the bank. Hence, the bank should create especial credit
risk mitigation mechanism.
Survey result shows there is no training for customers how to use the loan dispersed this
will create diversion of loan for other sectors. Hence the bank should facilitate short
training program for creditor to overcome this kind of serious problem.

The bank uses centralized credit processing technique in Addis Ababa which means all
type of loan except consumer loans are processed at center of head office level. Thus, the
bank should segregate the duty and responsibility at branch level in order to create
effective follow-up.
Reference

Abdou, H. & Pointon, J. (2011). Credit scoring, statistical techniques and evaluation
criteria: a review of the literature, Intelligent Systems in Accounting, Finance &
Management, 18 (2-3), pp. 59-88.

Anuj A. (2011). Credit Risk Management: Trends and Opportunities, Capgemini, Online
available At: www.capgemini.com/risk

Asia S. & Zaidi F.B. (2012). Design and Development of Credit Scoring Model for the
Commercial banks of Pakistan: Forecasting Creditworthiness of Individual Borrowers,
international Journal of Business and Social Science Vol. 3 No. 17. Available online
www.ijbssnet.com

Atakelt H.A. (2015). Emphatically Study on Credit Risk Management Practice of

Ethiopian Commercial Banks. Journal of Finance and Accounting, Vol.6, No.3. PP.134-
147.

Basel Committee, (July, 1999a). Principles for the Management of Credit risk. Basel
Committee on Banking Supervision.

Basel Committee, (September 2000). Best Practice for Credit Risk Disclosure.
Committee on Banking Supervision.

Basel committee on banking and Supervision (2001).Sound Practice for The

Management of Operational Risk. Basel committee publication No.86, Basel.

Cebenoyan, A. S., Strahan, P. E. (2004). Risk Management, Capital Structure, and

Lending at Banks, Journal of Banking and Finance, vol.28, p- 19-43

Colquitt J. (2007). Credit Risk Management: How to Avoid Lending Disasters and
Maximize Earning, McGraw-Hill, Two Penn Plaza, New York.

Edward I. A. (2006). Default Recovery Rates and LGD in Credit Risk Modeling and
Practice, Stern School of Business, New York, U.S.A.

Ganopoulou M. & Giapoutzi F. (2010). Credit Scoring and Bank Lending Policy in
Consumer Loans, International Hellenic University.
Girma M. (2011). Credit risk Management and Its Impact on Performance on Ethiopian
Commercial Banks, Unpublished Master’s Thesis Addis Ababa University.

Hagos M. (2010). Credit Management (A Case Study of Wegagen Bank Share Company
in Tigray Region), Unpublished Master’s Thesis Mekelle University.

Hand, D. J. & Jacka, S. D. (1998). Statistics in Finance, Arnold Applications of

Statistics, London.

Harrison O. A. (2012). Credit Risk Management and Profitability of Selected Rural

Banks in Ghana, Catholic University College of Ghana.

Hussein A., Ahmed E. & John P. (2007).On The Applicability of Credit Scoring Models
in Egyptian Banks, banks and bank systems, Vol.2, No.1.

Kargi, H.S. (2011). Credit Risk and the Performance of Nigeria Banks, Ahmadu Bello
University, Zaria.

Kolapo, T. F., Ayeni, R. K. & Oke, M. Ojo (2012). Credit Risk and Commercial Banks’
Performance in Nigeria: a Panel Model Approach, Australian Journal of Business and
Management Research, Vol.2, No.02.

Korir Mark .K, (2012). Effects of Credit Risk Management Practices on Financial
Performance of Deposit Taking Microfinance Institutions in Kenya, University of
Nairobi.

Margarita J., Kosta S. & Suzana T. (2014). Application of the Scoring Model for
Assessing the Credit Rating of Principals, Tem Journal , Vol.3, No.1. Online available on
www.temjournal.com

Michael K. Ong (2006), Risk Management –A Modern Perspective, Elsevier Inc, London,
UK.

Million G., Matewos K. & Sujata S. (2015). The Impact of Credit Risk on Profitability
Performance of Commercial Banks in Ethiopia, African Journal of Business Management
Vol.9, No. 2, PP.59-66, Online available at: http://www.acadamicjournals.org

MS. Asha S. (2013). Credit Risk Management in Indian Commercial Banks, International
Journal of Marketing, Financial Services & Management Research, Vol.2, No.7. Online
available at www.indianresearchjournals.com
Nayan J. & M. Kumaraswamy (2014). Retail Credit Risk Management in Indian Public
Sector Banks, Hemagangotri University of Mysore.

Patil J.B. (2014), Credit Risk Management in Indian Banks, International Journal of
Advance Research in Computer Science and Management Studies, Vol. 2, Issue 1,( P
309-313), Available online at: www.ijarcsms.com

Ronald W.A. & Karin J. (2014). The Economics of Collateral, The London School of
Economics.

Sanaders, & C.Ornett, (2005). Financial Markets and Institutions: An Introduction to the
Risk Management approach. McGraw Hill Publication.

Solomon G. (2013). Credit Risk Management Practice on NIB International Bank,

Unpublished Master’s Thesis, St. Mary University.

Sunitha R. & J. K. Raju (2013). Risk Management in banking Sectoran Emperical study,
Davangere University, Davangere.

Tesfaye B. (2014). Factors Influencing the Level of Credit Risk in the Ethiopian
Commercial Banks: The Credit Risk Matrix Conceptual Framework, University of South
Africa, online available on http://www.researchgate.net/

Thirupathi K. & M.Manoj kumar (2013). Risk Management in Banking Sector -an
Empirical Study, International Journal of Marketing, Financial Services & Management
Research, Vol.2, No. 2. Online available at: www.indianresearchjournals.com.

Tibebu T. (2011) Credit Risk Management and Profitability of Commercial Banks in

Ethiopia, Unpublished Master’s Thesis Addis Ababa University.

Thomas, L. C. (2000). A survey of credit and behavioral scoring: forecasting financial

risk of lending to consumers. International Journal of Forecasting, Vol.16, No.2: p149-
172.

Thomas L. (2002).Survey of Credit and Behavioral Scoring; Forecasting financial risk of

lending to consumers, University of Edinburgh, Edinburgh.

Tony V. & Bart B. (2009).Credit Risk Management: Basic Concepts, Financial Risk
Component, Rating Analysis, Models, Economic and regulatory capital: Published in the
United States by Oxford University Press Inc., New York.
Yang W. (2013). Credit Risk Management in Rural Commercial Banks in China,
Edinburgh Napier University.

Yong H.K. (2003). Credit Granting: A Comparative Analysis of Classification

Procedures, The Journal of Finance, Vol.42, No.3. Online available at
http://www.jstor.org/
Questioner

Dear respondents
The purpose of this self-administered Questionnaire is to gather data relating to the
“Assessment on credit risk management practice of commercial bank of Ethiopia.”
For fulfillment of the requirements of the thesis for the Masters in Accounting and
finance program of St.Mary University (MSc). The research will be conducted to assess
credit risk management practice of commercial bank of Ethiopia(CBE).I feel that your
contribution which means information obtained from you is essential for success of this
research. Thus, I appreciate your cooperation to give me your time for the success of this
research thesis. I assure you that the information to be shared by you will be used only for
academic purpose and kept confidential.

For further information and need my assistance while you fill the questionnaire please
contact me:

E-mail: biruk190@gmail.com or
birukdejene@cbe.com.et

Thank you for your cooperation

Yours sincerely
Biruk Dejene

I
Part I: Respondent profile
Please use this mark in the box “X” Where it applies
1) Job Title: __________________________
2) Highest educational level obtained
High school complete Certificate Diploma

Bachelor Degree Masters Degree PhD

3) Area (field of specialization) or major field of study
Accounting Management CPA
Economists Others please specify ____________
4) Years of work experience
0-5 years 6-10 years 11-20 years More than 20 years
Part II. Research related question
Please tick the level of credit risk being faced by your bank on the following economic
sector.
No Low High Very
Risk Risk Risk high risk
Agricultural loan
Manufacturing loan
Import and export loan
Domestic trade and service loan
Building and construction loan
Personal and ESL and mortgage loan
Co finance of project loan

Please rank which of the following best describe the major challenges faced in successful
implementation of credit risk management policy within your organization? 1-very
highly challenging, 2- highly challenging, 3-least challenging and 4-not challenging.

II
 1 2 3 4
High cost of information technology.
Lack of technical knowledge.
Lack of training within the organization about CRM.
Lack of employee’s motivation to implement.
Difficult to understand the policy and procedure.
Access to material related to CRM
Difficulty in quantifying risk
Information gap

What is the following factor of the Ethiopian environment on your banks affect credit risk
management practice?
Positive Negative No effect Both side
Government policy
Infrastructure facility
Background of the society
Level of Economy
Global economic crisis

Which of the following bank specific factor do you think are facilitate the occurrence of
nonperforming loans in your bank? Please rank the factor in order of their importance in
contributing to the occurrence of nonperforming loans in your bank.
1-most important, 2-important, 3-less important and 4- not important
1 2 3 4
Interest rate
Poor credit assessment technique
Size of the institution or the bank
Ownership type
Knowhow of employees
Credit culture of the society
Know your customer (KYC) principle
Growth of loan demand.
Lack of follow up by credit department
Allocation of the loan for other activities
Behavior of the customer
Time duration of loan

Tools of credit risk management

Which technique do you use for credit risk management in your bank? You can choose
more than one answer.
1) Collateral 2) Risk rating 3) Loan recovery 4) portfolio management

5) Credit approval authority 6) Diversification 7) Please state if any …………

Please rank the importance of the following factors in your credit granting process.
1-most important, 2-important, 3-less important, and 4- not important
1 2 3 4
Character: measures the borrower’s character and integrity
Capital: measures the difference between the borrower’s assets
Collateral: measures the collateral provided in case payment problems
occur
Capacity: measures the borrower’s ability to pay
Condition: measures the borrower’s circumstances

Please tick which of the following credit risk model you use for evaluation of credit risk.

Value at risk model

Credit metrics model
Altman’s z-score model
Merton-based models/KMV model/
Any Other, please specify ……………………………………….
Does the bank demand any collateral security before granting loan to its clients?
Yes No
IV
If yes, is collateral demanded for all type of loan?
Yes No
If No, specify the type of loan.
The bank lends up to ………………….. Percent of the value of the security offered.

Which of the following credit risk scoring is important in your bank? Please tick according to
their importance. 1-most important, 2-important, 3-less important, and 4- not
important
1 2 3 4
Marketing score
Application score
Fraud score
Performance score
Behavioral score
Early warning score
Collection score
Profit score

Does your bank perform the following technique for credit risk management? Please tick
Highly Used Least Not
Used Used used
Develop management information system
Periodic credit calls
Periodic visits of borrowers
Credit risk rating
Annual review of accounts
Risk scoring

What are problem encountered during debts recovery from customers?

………………………………………………………………………………………………
……………………………………………………………………………………………....
V
What step /procedure do you follow to recover non performing loan?
………………………………………………………………………………………………
………………………………………………………………………………………………
What forms of penalties are there for officers or credit approval committee which later
turns out bad?
………………………………………………………………………………………………
……………………………………………………………………………………………...
Which of the following best describes the way risk management is reported within your
organization? Risk reporting takes place:
Never Annually
Quarterly Monthly
Does the bank provide any advisory service to its loan customer?
Yes No
If yes, what form does it take?
………………………………………………………………………………………………
………………………………………………………………………………………………
Please provide your level of agreement as follows:
1-Strongly agree, 2-Agree, 3-Neutral,4-Disagree, 5-Strongly disagree
Credit processing/appraisal 1 2 3 4 5

There is credit policy and procedure with clearly stetted

eligible criteria.
There is independent risk management policy and procedure
from credit policy and procedure in your organization.
There are time credit granting and monitoring process is
overridden by directors, senior management influential staffs
The bank carried out credit processing activities independent
of appraisal function
The bank checks the borrower history before granting loans
Credit granting approval process establish accountability for
decision taken
The bank properly assessed the customer ability to meet
obligation
Credit administration
The bank has well structured documentation tracking system
for credit and collateral files
The process of credit administration is performed
independently of individual involved in the business
organization of credit
Monitoring and control of credits
The bank regularly undertake stress testing on overall credit
portfolio
Collateral coverage is regularly assessed and related to the
borrowers financial health
The banks periodically prepare credit quality report for
warning sign loan loss in any portfolio.
The bank monitor the business of client after granting credit
on regular bases
Customer are often given sufficient training on loan usage
Managing problem credit/recovery
The bank has appropriate criteria for credit classification
provisioning and write off
The bank has loan recovery procedure that clearly set out
how problem credit are to be managed
Adequate measures are put in place to recover nonperforming
loans

Which of the following principles improve the quality and capacity of credit risk
management the bank?
-Establishing an appropriate credit risk environment

-Operating under a sound credit granting process

-Maintaining an appropriate credit administration, measurement and monitoring process
-Ensuring adequate controls over credit risk
-The role of supervisors
Please write if you have suggestion and comment.

………………………………………………………………………………………………
………………………………………………………………………………………………

VII